Finding sources of financing for your business needs can challenge even the most resourceful business owner.
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Venture capitalists often require outrageous financing terms and commercial lenders offer terms that are designed to benefit them instead of you. Sometimes you think you would be better off borrowing from a total stranger. Well, maybe you're right.
One of the latest trends in financing is something called people-to-people lending. Leveraging the power of the internet, people-to-people lending connects people who need to borrow cash with people who are willing to lend it.
Here's how it works: Suppose you need to borrow $20,000 for your small business. Rather than pursuing financing through a traditional lending source, you can log on to Prosper.com or a similar people-to-people lending website where you can post a listing for the loan amount you need at the maximum interest rate you are willing to pay.
People who are interested in lending their cash resources then make bids based on the amount they are willing to lend you at the interest rate they believe is fair. When the listing period ends, the bids with the lowest interest rates are combined into a single loan. Amortized loan payments are withdrawn from your checking account until the loan is repaid in full.
The big benefit of a people-to-people loan is that the bidding process actually works in your favor by driving the interest rate down. The downside is that people-to-people loans also have some limitations and disadvantages over other funding sources.
The repayment periods of most people-to-people loans are limited in comparison to loans from commercial lenders. It's not uncommon for people-to-people loans to require a repayment period of three years or less. Shorter repayment periods translate into higher monthly payments, so make sure you are comfortable with the monthly payment amount before you initiate a listing. Also, it might not make good business sense to finance capital purchases over a shorter term, especially if the capital purchase has a useful life that is significantly longer than the repayment period.
Another reason that people-to-people loans are not typically ideal for capital purchases is that the amount you are able to borrow is limited to $25,000 or less. Depending on the size of your business, $25,000 may not go very far toward the purchase of a piece of equipment your business is depending on growth.
In some cases, people-to-people lending may be a good financing solution for individuals with less than perfect credit, although you might need to recruit your friends to help you get the best rates. Borrowers with good, but not great credit can invite their friends to endorse their listing and submit a bid. Their endorsements and bids appear with your listing, demonstrating support for your loan request. As the endorsements and bids begin to pile up, other lenders will be attracted to your listing and make bids of their own, driving down the rate and helping you to get the money you need for your business.