Try Social Lending as an Alternative to Banks

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Money is the life blood of every business. Gathering start-up capital or finding the funding for an expansion is crucial. There are certain institutions that we consider the best places to get those funds, such as a bank or an investor, but there are multiple funding methods beyond the traditional. Social lending, in particular, can provide a business owner with access to funds that would otherwise be unavailable. Also known as person-to-person lending or peer-to-peer lending, social lending lets individuals lend and borrow money without going through a bank or other traditional lender.

Looking Beyond Banks

When banks lend money, they have very specific concerns. Credit-worthiness of the borrower is a factor, of course. Loan size is another. Most banks simply can’t offer small loans; they can’t make enough money from them to support their operations and generate a profit. What's more, most banks will not lend to businesses that fall outside of what they consider the norm. If your business doesn’t match up with the bank’s standard, you may be out of luck.

But social lending offers a way to source funds that is a little more flexible.

If, for instance, you need only a few thousand dollars to purchase a piece of equipment or fund an expansion, most social lending sites make it easy to find a lender who can work with you. Even better? You can often get lower interest rates through social lending. Because you’re working directly with an individual with money to lend (and not a bank with employees and overhead), the costs of such loans are lower and fees and interest are lower as a result.

Some social lending organizations, such as Kiva, do not even allow their lenders to charge interest. However, Kiva, in particular, actually passes along their loans to local microfinance organizations both in the U.S. and abroad. Despite the fact that it is one of the best known social lending platforms, you cannot directly get a loan from Kiva.

Finding Money Online

There are a wide variety of social lenders online, including many that are country-specific. Because lending laws can vary dramatically country to country, most social lending sites have constraints on where borrowers can be based. Additionally, you’ll find that most loans are made out to you personally, rather than to your business. Some lending sites may check your personal credit history, but few will consider your business’ credit history. You will be ultimately responsible for any loans you take out through a person-to-person lender, no matter what happens to your business. Before making a choice and applying for a loan, you should take a close look at how each of the many lending sites operates, just as you would call around and get rates from a couple of different banks before agreeing to a specific loan.

A few sites that offer social loans include:

• Prosper
• Lending Club
• Funding Circle
• P2P Financial

The Social Lending Process

On most sites, the application process is relatively simple. You’ll be asked for basic information, like the amount of money you need and your plans for it. Some sites will run a credit check on you. You’ll also be asked to put together some sort of profile. Because your loan may come together piecemeal, with one lender offering a hundred dollars, another putting in fifty and so on, your profile is a key piece of the process. It’s what convinces lenders to choose to fund your loan.

Social Lending Versus Crowd Funding

You may have heard of crowd funding or crowd-sourced funding. It's a lot like social lending. Both leverage the power of the Internet to build communities and markets that aggregate small contributions of money. But they aren’t identical. Crowd funding usually comes down to soliciting pledges from sponsors or donors, without necessarily promising a return from the profits of the project or company being funded. In fact, it’s usually illegal to promise such returns because of the way securities laws govern investments. In contrast, social lending includes strict terms for repayment and your lender expects to be repaid according to those terms. There are many projects, especially creative ones, that pique the interest of individuals willing to pledge a small amount to see them completed. Unfortunately, this is not true for all business efforts. For that reason, business owners in need of capital will likely have better success finding funding with social lending than they might with crowd funding.