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While many businesses qualify for traditional loans, this isn't true for every operation. In recent years, peer-to-peer (P2P) lending has become a popular option for small and medium-sized enterprises (SMEs). But what is P2P lending? How does it work? And is it right for your business?

Key takeaways

• Your business accesses funding from a pool of different investors, usually for a fee

• P2P lending is a loan that accrues interest and requires repayment

• Businesses with a financial track record often get better interest rates than startups with no trading history

What is peer-to-peer lending?

P2P lending is an alternative source of funding for small businesses. It’s a loan, which means it’s a type of debt financing that you must repay with interest over a set period of time. Unlike equity financing, with P2P lending, you don’t need to give up any ownership in your business.

P2P lending is arranged through online platforms that enable your business to access funds from a pool of individual investors. This approach bypasses traditional financial institutions like banks, which typically provide standard business loans.Ìý

Since P2P borrowers and lenders negotiate terms directly, both parties can often achieve better rates than those available on the high street.Ìý

The Financial Conduct Authority (FCA) regulates the platforms. All administration involved in the lending process – uploading documents, communicating with potential lenders and managing applications – occurs digitally.Ìý

How does peer-to-peer lending work?

Each P2P lending platform has its own procedure, but the overall process is similar. If you’re thinking about peer-to-peer lending for your business, here’s what to expect:

1. Application stage

Once you find a P2P platform you like the look of, you need to complete an application form. Provide information about your business, its financial and trading history, your business plan and your loan needs.

2. Assessment stage

The platform reviews all the information you provide. As part of its assessment, it may carry out a credit check on you or your business and request additional information. The quicker you provide what it needs, the more straightforward the process should be.Ìý

3. Listing stage

Once you satisfy the platform’s checks, it lists your loan request, making it visible to potential lenders. Those considering investing can see details about your business and your reasons for borrowing money.

4. Lending stage

Potential investors pledge to lend specific amounts. Remember that P2P lending isn’t about receiving funds from just one investor – instead, you’re likely to receive small pledges from a number of investors. Once you have enough pledges to fulfil your stated investment goal, the P2P platform releases the funds to your business.Ìý

5. Repayment stage

Like any loan, you must repay the money. The repayment details are usually set out in advance, with repayments made monthly. You typically make the repayments to the platform, which then distributes the money back to your investors.

Peer-to-peer lending advantages and disadvantages

Peer-to-peer loans can be a good option for small businesses looking for quick access to finance, but they have their disadvantages too.Ìý

Advantages

• Access to finance. P2P lending can be much quicker than traditional lending methods, such as business loans and asset finance

• Competitive rates. If your business has a good credit history, interest rates can be more favourable than those available on the high street, making the overall cost of borrowing cheaper 

• Flexible. Many P2P platforms allow you to customise loan amounts and repayment terms

• Engagement. You can benefit from the opportunity to engage with individual investors interested in your industry, making P2P lending a great way to network and build new connections

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• Higher risk. If you have a low credit score or a limited financial history, lenders may view you as a risk. As a result, you may only receive offers for financing with higher interest rates

• Fees. P2P-lending platforms usually charge fees for their services. Make sure you know what these are to understand the overall cost of borrowing

• Limited amounts. You may find you can’t borrow as much as you can with traditional banks, which means P2P lending might not meet your funding needs if you require a large sum

• Credit score impact. Failing to keep up with repayments or defaulting on the loan can impact your credit score, making borrowing more difficult in the future

What should I consider before using peer-to-peer lending?

Before jumping into a P2P lending application, it’s worth considering a few things.Ìý

P2P lending often works best for businesses with some trading history. If you’re a startup and can’t provide sales sheets or tax returns, you may only receive offers for small amounts with high interest rates.

On the other hand, a detailed business plan remains one of your business’s greatest assets. Even if you are new to business, crafting a well-thought-out plan that outlines your business model, market research and financial projections can greatly benefit you.

Your business plan should also specify what you need the funding for, so consider this carefully.

Finally, research different P2P platforms to find the one that best meets your needs. Check the fees they charge and the industries and investors they specialise in. You don’t want to waste time on an application if the platform charges too much or doesn’t typically include your type of business.Ìý

What are the alternatives to peer-to-peer lending?

If you want to avoid giving up equity in your business, you could consider traditional options such as business loans, overdrafts or credit cards. If you need funds for a specific purchase – like a vehicle, equipment, or technology – asset finance might be a good fit. If cash flow is tight due to delayed payments, invoice finance could be a better solution.

You can also consider equity finance. This is where you give up a stake in your company in return for investment. Unlike debt finance, you don’t need to pay the money back. Options here include venture capital, equity crowdfunding and angel investment.Ìý

Or you could go it alone and use your own money to fund your business in a process known as bootstrapping.