Along with grants and investment, almost every small business relies on finance to invest in new equipment and maintain positive cash flow – whether it be start-up loans, asset finance or business credit card.
Whereas major companies may already have large cash reserves built up over years and backing from investors, most small and medium-sized enterprises (SMEs) have no such buffer. They depend on finance to tide them over seasonal fluctuations, or the weeks spent waiting for customer payments to come in. Finance is also essential if they want to move to new premises or upskill their team as they scale up.
Like the consumer finance market, business finance has become highly-competitive in recent years, with firms typically turning to their bank, commercial broker, accountant or digital broker. They may also use marketplaces, such as Funding Xchange and Funding Options.
One route you may not have considered before is peer to peer lending (also called P2P lending or marketplace lending), which involves borrowing from private investors via an intermediary rather than a traditional bank or building society. P2P has been around for well over a decade now and is an established part of the business finance market, helping to create and safeguard millions of jobs across the UK.
This guide aims to give you an overview of peer to peer lending, to help you decide whether it’s right for your business.
Peer to peer lending – what are the advantages and disadvantages?
Years of stubbornly low interest rates mean some savers have turned to peer to peer lending as a way of bolstering their income. As with any form of investment, there are risks where the borrower could lose their money – but with yields ranging from around 3% to over 10% in some cases, it could be a more attractive alternative to simply saving.
The process is straightforward for investors and they can sign up online with as little as £1, although many expect a minimum of £1,000. As well as the projected returns, many will undoubtedly be swayed by the fact that they’re supporting independent businesses to take their next steps.
Funding Circle is one of the best-known providers and it works exclusively with small businesses, so far lending around £8.7billion and helping over 81,000 small businesses. Other P2P lending platforms include Zopa and Lending Crowd but always research different companies and products to find the best deal for you.
Despite being fairly new, P2P lending follows the same formal process as any other loan application, and can provide the funding you need to take your business to the next level. There are a wide range of products available with different rates and terms.
But as with any loan or investment, it’s important to understand the drawbacks and risks too. The rates and fees could make it more expensive for borrowers, while investors have been warned that unlike with savings, they are not covered by the Financial Services Compensation Scheme (FSCS). The COVID-19 lockdown has also impacted the market, with some providers closing to new investors and taking longer to process withdrawals. In a far-from-certain economic climate, their ability to bounce back or even survive depends on whether the majority of their customers keep up with their repayments or default.
Business loan rates vary depending on factors such as your business credit score. Peer to peer borrowing is not necessarily cheaper than a bank loan but it can be, so compare your options.
Some providers cater specifically for SMEs, so they understand the cash flow and payment challenges you face. Online applications are quick and straightforward, and you should receive a decision soon afterwards. Once approved, the money could be in your bank account by the next working day.
Many firms perform a soft credit check first, so you receive a quote without negatively impacting your credit score for any future applications you make. Any firm offer is based on you granting permission for them to run a hard credit check, which looks at how well you’ve met repayments previously, among other things.
It’s important to note that peer to peer lending is not always suitable for start-ups, which might be perceived as a riskier investment compared to established businesses. As part of your application, you normally have to submit business accounts, which new companies don’t have. There are, however, a number of finance options for start-ups, including Start Up Loans – a government-backed initiative that provides loans of between £500 and £25,000.
Improving your business credit score
Whatever type of finance you need, a good business credit score is essential if you want to avoid paying high interest rates for finance. Any limited company can establish and improve their business credit score through responsible borrowing, prompt repayments and good practice – such as filing your accounts with Companies House and paying your invoices on time.
Incorrect information registered with Companies House (names of directors, office address and so on) could also impact your score, yet it’s easy to fix by logging onto the government website and updating any changes.
A tool like My Business Profile can also help ensure your business credit score is always on track. By looking at the top five factors currently influencing your score, you can take steps to improve it, while automatic alerts let you know when anything significant changes. It’s an opportunity to see what lenders (including peer to peer providers) see when making a decision on a loan.
Questions about peer to peer lending
If you’ve always taken out conventional bank loans and credit cards, you may be sceptical about how peer to peer lending could work for you. As we have seen, there is little to differentiate the application and repayment process from any other kind of lending and it could be another funding option for growing businesses. Below we answer some questions you might have about it.
Why don’t more people talk about it?
Lack of awareness and trust could be factors, as is the fact that some incur fees (although this may be included in the monthly installments). Inertia might be another reason, in the same way many of us rarely switch current accounts or energy companies, even if we could get a better deal elsewhere.
Will I find out who the investors are?
The intermediary protects the identity of both the investor and borrower, so you don’t have to share details of your venture. In terms of the application process, lending criteria and repayments, it’s no different to taking out any other loan.
Is it secure?
It’s a good idea to check whether a provider is authorised and regulated by the FCA (Financial Conduct Authority) before proceeding. Search the Financial Services register here.
How are late payments and defaults handled?
Fail to keep up with your monthly repayments and the provider will try to recover the costs in the same way a bank or credit card company would. As well as having to pay back the loan, any default can bring down your business credit score, making it difficult to obtain finance. You may also find that some suppliers don’t want to work with you, or impose strict payment terms to mitigate the risk.
Making the right decision for your business
Before starting a business loan application, weigh up whether you can afford the monthly repayments and think about what would happen if revenue dropped suddenly. A good business credit score is essential if you want to access the best rates, so check it regularly and take steps to improve it if necessary.
If your business is struggling because of COVID-19, it is worth checking the government’s website for information on the Business Interruption Scheme, Future Fund and Bounce Back Loan.
No matter how cautious you are, borrowing always brings risks – whether from customers who don’t pay on time (or at all) to misjudging the level of demand for your product or service. But it also gives you the freedom to scale up, invest in your team and premises and ensure you have the equipment to operate successfully.
As long as you stay in control of your finances, and set out a sustainable growth strategy, peer to peer lending can be an effective alternative revenue source for ambitious SMEs.
For more information on how Experian My Business Profile could help you track and improve your business credit score, click here.