Peer-to-peer (P2P) lending has become increasingly popular with entrepreneurs and small business owners as an alternative to a traditional bank loan for a startup, or to fund an existing business venture. Loans are typically offered via a website operating as a P2P marketplace, using financial technology, to connect borrowers directly with investors. In doing so, the middleman – the financial institution – is removed from the process.
In the case of a P2P loan, an investor opens an account and deposits money which is dispersed in the form of loans. The investor’s goal is to achieve a better return on their investment than would be possible through a savings account, while, in most cases, the borrower is able to secure a lower interest rate.
Here, we look at the pros and cons of securing funding through peer-to-peer lending.
The Pros
Lower interest rates
The most obvious advantage is due to the fact the middleman has been cut out. P2P lenders don’t have the same overheads as traditional financial institutions: there are no physical branches and no shareholders to pay. This usually means lower interest rates which can mean big savings over the term of the loan.
Faster, more convenient funding
Getting a loan from a traditional lender can mean a lot of bureaucracy and paperwork, taking weeks or even months to get approval. With peer-to-peer lending, it’s all done online. Theoretically, this means that the loan can be approved within hours of application and funded quickly after – an obvious benefit for firms that need to move quickly to take advantage of a business opportunity or deal with an unexpected expense.
Increased lending opportunities and flexible terms
Since P2P loans aren’t traditional loans, they can be customised to meet the needs of borrowers. That means the loan amount, repayment period and even the interest rate can be tailored to suit the needs of the borrower. Crucially, this also means that businesses unable to secure traditional funding, perhaps due to a flawed credit history, have more chance of securing the access funding they require.
Meet like-minded investors
Investors that fund P2P loans often have an interest in same industry or niche as the borrower and may even be able to provide expertise to help the borrower achieve their goals. This can even lead to a long term relationships or a partnership.
The Cons
Greater chance of default
While this isn’t such a problem for borrowers, P2P loans can be risky for investors as the chance of default is higher than through the traditional financial system. That said, there tends to be greater transparency and control for both investors and borrowers and platforms will typically use robust risk assessment techniques to evaluate creditworthiness.
Platform risk
P2P platforms like many new fintechs are more susceptible to fraud, cybercrime and regulatory change. Often these vehicles are unregulated, do not provide insurance and state bodies do not provide any of the protections that are normally afforded to traditional financial services.
Additional fees
Every P2P platform needs to be profit-making to exist. To achieve this, there will often be additional fees for borrowers. Higher interest rates may also apply for those with a poor credit history.
As we can see, peer-to-peer lending comes with more advantages than disadvantages if both borrowers and lenders are happy to deal with a certain level of risk. Certainly, lower rates of interest, faster access to loans and more flexibility make them attractive for small businesses and startups that may not be able access funding through traditional business lenders.
However, borrowers should be very careful when choosing P2P platforms. In-depth research and due diligence is needed to find the one that suits your needs best. As with any business venture, owners should take utmost care to ensure all legal angles are covered regarding their business interests.
JPP Law is here to help with the legal aspects of funding a venture. Whatever stage your business is at, get in touch for your free consultation with one of our startup and scaleup solicitors.
