Rise of peer-to-peer lending

Charlotte Petris gives My Business an overview of peer-to-peer lending, and the opportunities it presents the SME community to fund new growth.

Peer-to-peer (P2P) lending, also known as marketplace lending, is an industry in its infancy in Australia, but one which is experiencing rapid growth. A recent Morgan Stanley report on the industry says P2P loans will soar to $22 billion in Australia in the next five years, $11.4 billion of this in lending to businesses.

Like so many other industries, digital technology is changing the landscape of financial services, improving the experience for the end user and demanding a rethink of the traditional financial models. Online platforms are beginning to challenge a banking industry that has been largely unchanged for decades.

One of the biggest issues for businesses looking to raise finance is that they aren’t aware of the options that are available to them. However, it’s not just knowing they exist, but also understanding which platforms are the most appropriate.

What is P2P lending?

P2P lending is the practice of lending to peers without going through traditional financial institutions. An online platform connects people who want to borrow money with people who want to invest.

A loan application form about to be filled out By operating more efficiently with a much lower cost base, these platforms can keep fees and rates low. They utilise technology to provide an online service that is more customer-friendly with fast approval processes.

Why now?

There is a huge gap between small business financing needs and the availability of capital from traditional sources. For many, especially young and new businesses, the bank door remains firmly shut and for those that do approach them, the rejection rate is high. A good proportion of these are actually viable and are rejected simply because they don’t meet the required profiles of the largest banks.

Following the 2008 financial crisis, global regulation has introduced greater capital requirements for traditional banks. Many of them have retrenched from certain types of lending, impacting their ability to extend credit to businesses. At the same time, technology is enabling new competitors to emerge.

The Bank for International Settlements has recently ranked Australian banks as the most profitable in the world. The big four Australian banks have a wider net interest margin than most of their peers overseas. This indicates a lack of competition in the sector, leading to an inflated cost of finance for borrowers.

Banks have historically controlled most of business lending because they have the resources and regulatory approval to fund loans. However, the traditional lending model has some key inefficiencies. Interest rates are not individualised, the costs of underwriting loans are high, and loan decisions take months. P2P lenders solve the banking model’s inefficiencies by leveraging technology to change the way businesses access the capital they need to grow.

How is P2P different?

P2P platforms are introducing competition by breaking the traditionally closed lender-borrower relationship that has dominated this market and producing greater price transparency in the process. The key factors that make these alternative finance models such an appealing option include:

  • Access to capital – finance opportunities outside of traditional lenders
  • Speed of service – save time with quick online application processing speeds
  • Simplicity – simple, clear and transparent processes
  • Convenience and flexibility – no more lengthy meetings with bank managers
  • Modern underwriting – combining technology with innovative credit scoring and information models utilising non-financial data (for example, assessing a business’s reputation, customer reviews, ratings and social media footprint can provide a more accurate picture of its risk)

What are my options?

If you’re looking to raise capital for your business, it’s smart to be aware of your options. It’s important to choose a suitable funding product that’s right for your business. A long-term loan probably isn’t the answer for a short-term cash flow need and vice versa.

P2P lending for business falls into three broad categories: equity finance, business loan and working capital finance.

Equity finance

If you are launching a business, consider crowdfunding. Crowd-sourced equity funding involves raising funds from a potentially large group of individual investors.

While P2P lenders replace the bank, crowdfunding is an alternative to venture capitalists. There are two main crowdfunding models: equity-based crowdfunding where people contribute funds to a business or project in exchange for equity; and donation-based crowdfunding where people donate to a project in exchange for tangible, non-monetary rewards.

A hand holding a collection of notesKickstarter and Pozible are perhaps the best-known platforms for creative projects. The biggest challenge for businesses that have successfully used these platforms has been developing a marketing and social media strategy around their offer.

OurCrowd and locally based VentureCrowd are focused on investing in equity for early-stage Australian businesses. Once you sign up to the platform, you place what is essentially an advert for the proposed fund raise.

Along the lines of Shark Tank, the pitch must set out a minimum funding amount, which must be met for the raise to go ahead. Expect a rigorous due diligence process to be accepted on to these platforms.

Business loan

If you don’t want to give away equity, a business loan might be right for you. The P2P lenders here all differ in terms of costs, size of loan, term and security.

ThinCats, a spin-off from the UK, are now offering loans to businesses in Australia. Loans range from $50,000 to $2 million, with fixed monthly instalments over periods from six months to five years. You will be required to give security and will need to have an established and profitable business.

Recently launched Marketlend provides loans from as little as $2,000 up to $1 million, over terms of three years and five years.

There are other alternative finance options that, while not P2P, differentiate from traditional lenders with their use of technology. OnDeck, a large US-based platform, has recently announced their expansion to Australia, expected to start offering loans to small businesses up to $250,000 towards the end of the year, with terms of three to 24 months. Moula, locally based, typically fund loans of $1,000 to $20,000 over a maximum term of six months.

Initially only funding eBay merchants, they have been expanding to other e-commerce retailers. Prospa offers unsecured loans from $5,000 to $250,000 for a term of three to 12 months, with daily or weekly repayments.

P2P lenders solve the banking model’s inefficiencies by leveraging technology to change the way businesses access the capital they need to grow.

Working capital finance

If you have customers that have businesses and your receivables are a significant asset on your balance sheet, your business may benefit from working capital finance.

Invoice finance is a form of short-term borrowing and means you get paid immediately instead of waiting 30 or more days for your customer to pay. InvoiceBid is a locally based P2P invoice finance platform, funding invoices from $10,000 and advancing up to 100 per cent of the invoice value.

Depending on the platform and the type of finance, be prepared to provide such information as financial statements, asset data, a business plan and information on the directors. An information memorandum and term sheet will also be required for equity funding.

Though crowdfunding and peer-to-peer lending are relatively new in Australia, there are early success stories.

There is currently a unique opportunity to completely reshape the future of banking. The speed and efficiency of the internet will change the game for good. New models are continuing to emerge with new players expected to enter the market in the coming months. Which one is right for you depends on the amount of cash required, how long this is needed, and the security that is available.

Small businesses will always need banking facilities and services to deposit money and manage cash flow, but when you look at what else banks offer, businesses can now get those services and products from many other sources, often more cheaply, easily and quickly.

Charlotte Petris is a chartered accountant and co-founder of InvoiceBid, a peer-to-peer platform for short-term finance.

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