Small Business Needs to Embrace P2P

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Crowdfunding and Peer to Peer (P2P) lending is exploding in the media right now. Everyone is hyped up on the chance to go outside the traditional spheres of lending and raising capital. Everyone, it seems, except the small business. These alternative forms of lending making up a minor fraction of the business loans that are issued right now.

Here’s how it works. The small business meets with backers online. They tell these folks how much money they need to have for a financing package and put together a pitch about how awesome their business happens to be. The backers then decide if they want to get involved so the loan can be funded. The interest rates are similar and the payments are structured, but instead of the interest return going to the bank, it goes to the backer.

Why Aren’t Small Businesses Embracing This?

In frank terms, the average small business isn’t in a position to take advantage of what the P2P market can provide. Most backers aren’t wanting to invest their resources into a loan that has a high potential to default. They want a virtual guarantee for their return with an easy exit. That’s why most P2P loans go to businesses that have a long track record of success.

Crowdfunding is where most small businesses turn to get the cash that they want. Kickstarter in particular has attracted the small business to their platform because of the ease in starting a crowdfunding campaign. The small business puts together a package of rewards, offers them up as an “investment” (because it’s more of a pre-order than an investment), and gets to work promoting it.

The benefit of crowdfunding goes beyond the structure of how money is raised. Crowdfunding dollars, you see, don’t have to be repaid with interest. They aren’t paid back at all. P2P lending, however, requires the small business to have a certain amount of profitability.

Just 3% of Small Businesses Are Crowdfunding

To say that a majority of small businesses are embracing crowdfunding, however, would also be incorrect. In a recent survey by Manta, 97% of business owners said that they hadn’t used crowdfunding for their capital needs. This is compared to the 98% of small businesses which aren’t using P2P lending. Why are these participation figures so low?

One of the main barriers that is in place is the qualification process. CircleUp, a platform which focuses on P2P lending, only accepts 2% of applicants at the start-up stage. Some platforms won’t even accept an application during the concept stages of planning.

Then there is the fact that the interest rates on P2P products are generally 2x-3x higher than what other lending options tend to be. On one popular P2P site, Lending Club, the interest rates for a P2P loan can be as high as 19%. When you can get a subsidized small business loan at 5%, which is the better decision to make? That’s why so many small businesses are opting for the traditional forms of financing right now.

Is Technology Getting In the Way?

When asked why they weren’t getting involved with the P2P lending market, most small business owners cited their lack of technology awareness or a distrust of the service itself. Although these reasons seem valid on the surface, the fact is that these sites are easy to use and just as secure as making an online purchase. Since many start-ups are based on technology as well, the reasoning sounds more like an excuse not to get involved instead of an actual barrier being put into place.

When you compare 5% to 19%, there really is no comparison. The excuse helps to make the P2P market not feel so bad.

That’s also why crowdfunding is a higher priority. Even if you don’t meet your goal on Indiegogo, you’re going to get some cash after the 9% take off of the top. The costs are taken care of up front and you’re left to spend your capital based on the promises that were made in the campaign.

The P2P market is young and backers are learning. There is more risk involved in a small business investment, so the interest rates are naturally going to be a little higher in this world. Backers need to make a return. As it evolves, however, expect the P2P world to begin learning from the feedback that 98% of businesses are giving it right now.

It’s too expensive, too cumbersome, and too risk for a business to use it.