In simple terms peer-to-peer is lending from one person to another. There are a number of UK providers to help facilitate these transactions and provide a more sophisticated level of security to both lenders and borrowers.
(For ease of reference this guide will refer to these providers as facilitators because technically they do not provide finance they only bring lenders to borrowers and vice versa.)
There are a number of peer-to-peer finance operators in the UK (although no regulatory body) with the largest three being Funding Circle, Rate Setter and Zopa. The global recession has actually contributed to the growth of peer-to-peer lending, with facilitators springing up around the globe, including Prosper in the USA, Smava in Germany and Communitae in Spain.
This type of finance suits start-up, micro and small businesses, though there are no restrictions and larger businesses may use this as an additional source of finance. It is often used in conjunction with other sources of finance.
If for example a business wishes to borrow £500, the amount may be borrowed from as many as 50 individuals, reducing the risk to each lender to £10. The borrower may not receive the finance in one go, it may build as more and more lenders are willing to lend.
The terms of payment are also negotiable they can be for months or years, though in most terms will not exceed five years. Facilitators will also manage and chase outstanding debts, removing the necessity to chase debts from borrowers yourself.
The facilitators make their revenue by charging lenders for lending and borrowers from borrowing. This charge covers the cost of facilitation, admin, vetting, agreements, debt management and money transfers.
As a borrower’s credit worthiness increases so does the number of lenders wanting to lend, this reduces the borrowing cost by bringing in the increased competition element.
A business will maximise its chance of obtaining finance at the best possible rate if it prepares thoroughly before applying for peer-to-peer lending. It should consider the following direct costs:
- compliance costs
- professional advice
- reporting obligations.
Much of the initial cost will be incurred by the preparatory work. This will include grooming the company, obtaining key staff and having the right management structure in place. A business plan will form the cornerstone of any negotiations.
Legal fees will vary depending on if other services are provided, the complexity of the business, its size and risk to the lender. Legal costs will also depend on the stage of your business. For example, if you are established, the business angel may instruct a due diligence exercise prior to investing.
Fees to prepare management accounts will vary depending on whether other services are provided; bookkeeping, for example, and also on the complexity of the business, its size and the frequency of issue.
Facilitators promote the fact that you can receive confirmation of finance within 24 hours – but this does not include preparation time (eg for preparing the business plan and forecast).
- the judgement on whether you will obtain the finance is always a person, there is no automated process apart from the initial vetting such as credit rating
- the rates for lenders and borrowers are often more competitive when compared to traditional finance options, this is helped by the fact there are not as many overheads and staff costs often associated with traditional financial institutions
- although you may obtain finance through a facilitator, the options for lending is potentially thousands of people
- the cost of this finance is more transparent (due to a simpler process)
- relatively quick, from application to receiving the finance
- independent from your bank borrowing so can be used together with any other source of finance.
- not particularly suited to individuals or businesses with low credit ratings
- no over-arching regulatory body so it may not have the status to be a commercially viable option
- little competition amongst facilitators, although as more come to market this could become an even cheaper form of finance
- not covered by the Financial Services Compensation Scheme.
The main alternative source of finance is friends and family, which though unregulated, the expectations should be similar. Hire purchase / leasing is also a viable alternative.