The budding online peer-to-peer business lending industry is dangling healthy returns before retail investors and quick loan application processing speeds to advisors and other small business owners seeking loans to expand.
Peer-to-peer lending—also known as “marketplace” lending—operates by having a Web company sell baskets of loans to investors.
While the returns can seem suspiciously high, the largest business-only P2P lender, Funding Circle, promotes prudence by only lending to established firms, said co-founder Sam Hodges, who spoke at a House Small Business Committee hearing on peer-to-peer lending on Wednesday.
Hodges said Funding Circle is focusing on lending to businesses that have been in business for more than eight years, with at least 10 employees and $1 million to $2 million in revenue.
At a bare minimum, a business must have been in existence for two years and have been profitable in at least one of the past two years, he said.
In addition, the Web site requires prospective borrowers to provide financial statements, asset data, a business plan and information on the principals.
The loans are from $25,000 to $500,000 for one to five years.
“These are not start-ups. They are established businesses,” said Hodges.
Fraudsters pretending to be established businesses and applying for loans is an extensive problem for Funding Circle, said Hodges, adding the firm has been successful in weeding them out.
The broker-dealer, which is registered with the Securities and Exchange Commission, limits its lenders to accredited investors with at least $1 million in assets outside of a main home, with at least $50,000 to make available to Funding Circle borrowers
To protect themselves, Hodges said Funding Circle let’s investors choose the individual loans they want to participate in or take advantage of baskets of loan pieces the company puts together, ranging from low risk to high risk.
The default rate on those baskets over five years has ranged from 1 percent to 5 percent, with an average of 2 percent.
A peer-to-peer industry blogger Peter Renton said diversification is critical.
“If you have five loans of $20,000 and one defaults, you’re screwed,” said Renton, who also spoke at the congressional hearing.
He urges P2P investors to have at least pieces of 100 different loans in their portfolios to protect themselves.
While peer-to-peer borrowing can cost double the interest rates charged by banks, many firms that can get bank financing go the P2P route to save time and for the easy application process.
Renton said many peer-to-peer business lenders approve loans in a week or less, while banks often take one to three months.
Financial advisors and other small businesses that want to shop for the best terms for P2P loans can go to lendio.com and fundera.com, much as they might go to kayak.com or orbitz.com to look for the best air fares, he said.