Is a Peer-to-Peer Loan Right for You?
From smSmallBiz
AS CREDIT TIGHTENS, a growing number of entrepreneurs are turning to peer-to-peer lending sites to get the cash they need. But such loans can hurt personal credit scores — and potentially get business owners in over their heads, warn credit and lending experts.
Peer-to-peer lenders such as Prosper , Lending Club and Zopa provide online forums through which people looking for a cash fix can seek out unsecured loans (of typically less than $25,000) from willing lenders. On Prosper, for example, a newbie entrepreneur can list the amount they want to borrow and the interest rate he or she is willing to pay; lenders then bid on the loan eBay-style. Lending Club and Zopa similarly match individual borrowers and lenders.
For business owners, the attraction to peer-to-peer lending is simple: They're often able to get loans more easily and more cheaply than they would at a traditional lender. Start-ups have long found that their limited track record makes it difficult to secure lines of credit or conventional bank loans. But now, as a result of the credit crisis and softening economy, even established businesses are finding it harder (and costlier) to obtain money from credit-card companies or banks.
Peer-to-peer lending sites, which typically promise to deliver loan money in a matter of days, are "definitely addressing a gap in the market," says Gerri Detweiler, a credit specialist in Sarasota, Fla., and co-founder of BusinessCreditSuccess.com, an advice site for business owners. For the business owner who depleted his personal savings and doesn't have any friends or family members to turn to for help, or for the entrepreneur who has been denied funding at every turn, peer-to-peer loans can seem something like a miracle.
But business owners looking for a peer-to-peer cash infusion should proceed with caution. For starters, "while the borrower may think of [a peer-to-peer loan] as a business loan, it's really just a personal loan that you're going to use for business," Detweiler warns. "By adding a new loan to your debt, your credit score may go down."
On Zopa, for instance, a business owner may seek a so-called "small business loan" to finance a new or existing enterprise. But the loan, which is based solely on the owner's credit record, will be reported on their credit report as a personal loan instead. Zopa CEO Doug Dolton notes any borrower who seeks a loan through the site is provided with information stating that the loan is a personal loan. To get a free quote, business owners must provide their Social Security number and authorize Zopa to obtain their credit reports. "It's immediately obvious that what we're doing is about your personal credit score," he says.
Yet, some business owners might not be aware that peer-to-peer loans, just like personal credit-card debt, are considered "consumer" debt, even when used for business purposes. "The dilemma is that credit-scoring models were not built to take into account 'atypical' examples,' such as small-business expenditures," says John Ulzheimer, president of consumer education in Atlanta for Credit.com. An entrepreneur with limited financing options might turn to a peer-to-peer lender (or a personal credit card) to buy, say, pricey office equipment or machinery that can help him grow a profitable business. But the credit-scoring model would simply view that person as "a consumer who has an insane amount of debt," he says. As a result, the business owner's credit score could plummet, making it difficult to attain future loans from traditional lenders, and even credit from vendors or suppliers.
Peer-to-peer lending sites, similar to credit cards, also make it a little too easy for a business owner to get their hands on money. To combat default, some sites stipulate that a borrower must have a minimum credit score of at least 640. Lenders make decisions based on borrowers' credit history and existing debts, but they may also be swayed by individuals' personal appeals for cash.
"Sometimes, the easier the lending gets, the more you get yourself into trouble," says Gene Fairbrother, lead small-business consultant in Dallas for the National Association for the Self-Employed, a trade group. For example, some business owners turn to peer-to-peer lenders because they've been rejected by traditional lenders, which often require loan applicants to meet strict criteria such as the famous 5 c's — capital, character, capacity, collateral and conditions.
"If you can't get it through other sources, maybe that's a symptom of a bigger problem," he says.
Before seeking money from an online site — or any lender, for that matter — business owners "need to sit down and take a really hard look at their own house, and make sure they are not making a bad situation even worse," Fairbrother advises. "They should have a good grasp of their financials, and do a cash-flow projection to make sure they can pay back the loan." A business owner who struggles to read a balance sheet should seek help from an accountant, tax advisor or a consultant, or get counseling from the Small Business Administration's Small Business Development Centers or other resources, he recommends.
Cash-strapped business owners should exhaust other options — such as scaling back operations, negotiating better rates for office supplies or insurance, or downsizing their offices — before taking on more debt, especially debt that can hurt their credit record going forward. A peer-to-peer lender "absolutely is a resource," Fairbrother says. "But it shouldn't necessarily be the first resource."
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