P2P Lending for Small Businesses: Pros and Cons Explained

Imagine waking up one morning thinking that you have finally come up with that one genius idea for a business. You have spent many sleepless nights dreaming and preparing to get it right. But there is one thing that keeps holding you back, that is funding. 

You will not be too surprised if you are not the only person facing this problem. So traditional funding options, like banks, come with long approval processes, strict eligibility criteria, and often, that unpleasant “no” when you do not fit into their rigid boxes.

Here’s where peer-to-peer lending fills the gap – the alternative form of funding that is rapidly changing the game for small businesses and entrepreneurs. Since fintech has redesigned the current framework of finance, P2P lending has flexibility at its core. Let’s understand how lending has transformed the way small businesses establish their groundwork and scale up.

Challenges of Traditional Small Business Funding

It is only when we truly understand how difficult it is to access funds for small businesses through the banks, we appreciate the full extent of the revolution created by P2P lending.

First of all, there are strict eligibility criteria. Banks require good credit scores, a good financial history, and they insist on collateral-which is not possible for businesses that haven’t built up yet. New entrepreneurs are always likely to struggle with a limited history of finance. If your business is just launching, how do you show years of profitability? 

Then, there is the wait for approval. Applying for a loan from a bank can take weeks, from the submission date to when you can access the funds. For most entrepreneurs, it is this wait that becomes the difference between seizing a market opportunity and missing it.

The other major drawback is limited flexibility. Bank loan packages are usually standardized, they have fixed terms. If you need something more customized, say a cash flow loan for seasonal expenses, forget about it.

Finally, for those not meeting these criteria, the answer sometimes is so simple: a no. Indeed, thousands of entrepreneurs leave the bank empty-handed, without knowing where to go next.

P2P Lending: A Game Changer for Small Businesses

P2P lending removes most of these problems as it can offer fast and easily accessible finance in many situations. However, what is P2P lending, really?

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In simple words, P2P lending is a platform where individuals (lenders) lend their money to a borrower directly from an online platform instead of engaging with traditional banks. These platforms act as intermediaries between lenders and borrowers who seek good amount of returns by lending their money to borrowers.

What has always been good thing about P2P lending is democratized access to financing. Businesses no longer need to jump through hoops to meet a bank’s criteria. Lenders, on their part, can lend to borrowers in which they believe and collect interest in the process. It is a win-win for the two sides.

Key Benefits of P2P Lending for Entrepreneurs

Now that the setting has been drawn, let us know how P2P lending empowers small businesses and entrepreneurs in very real ways.

1. Faster Access to Capital

P2P lending is known for the speed of the process. In conventional banks, loans can take weeks to get approved; however, P2P platforms like LenDenClub often provide funding within 2 hours once you are eligible. It is critical for entrepreneurs looking for quick access to capital. 

2. Variable Terms in the Loan

P2P platforms usually tend to offer flexible loan terms based on the specific requirements of the borrower. Either you need a short-term loan for meeting an urgent expense or a long-term loan for growth, different business models are accommodated by the P2P lending platforms.

This flexibility would be very convenient for entrepreneurs managing seasonal businesses or business persons with variable cash inflows. 

3. Tailored Funding for Every Stage of Business Growth

P2P lending supports businesses of all ages. Whether you’re just starting or expanding, P2P platforms offer a range of loan options to match the needs of different businesses.

P2P Lending Promotes Financial Inclusion

The most powerful appeal of P2P lending is its nature toward supporting financial inclusion. Most of the traditional banks end up ignoring all important groups, for example, women entrepreneurs, rural business people, and others from disadvantaged communities. P2P platforms open up opportunities for these groups to access the funding. 

Challenges and Risks

P2P lending has many benefits, it’s not without risks. For individuals, higher interest rates may apply if they are considered high-risk borrowers. And of course, default risk of some form exists on P2P platforms as well, which can naturally make lending more difficult for lenders.

It’s important for small businesses to carefully evaluate the terms of the loan. As with any financial decision, understanding the risks is essential.

The Future of P2P Lending for Lenders and Borrowers

The future of P2P lending looks incredibly promising, especially with the new guidelines introduced by the Reserve Bank of India (RBI) that ensure the safety and reliability of these platforms for both lenders and borrowers.

1. Prohibition on Credit Enhancement and Guarantees: One of the significant changes is the prohibition on P2P platforms from offering credit enhancement, to make sure that platforms remain neutral intermediaries and do not bear credit risk.
2. Escrow Mechanism: To enhance the security and transparency of fund transfers, all transactions between lenders and borrowers must now be processed through bank-operated escrow accounts. 
3. Cross-Selling Restrictions: The RBI has also placed restrictions on cross-selling by P2P platforms. Except for insurance directly related to loans, platforms are prohibited from selling additional products. 
4. Lending Cap: A cap has been introduced to limit the exposure of lenders to Rs 50 lakh across all borrowers through P2P platforms. Additionally, lenders extending more than Rs 10 lakh in loans must provide a Net Worth certificate verifying that they have a minimum net worth of Rs 50 lakh. This ensures that lenders can safely manage their lending activities.
5. Matching Policies: P2P platforms must now follow a non-discriminatory, board-approved policy when matching borrowers and lenders, to make sure there is fairness in the process. 
6. Disclosure Requirements: Transparency has become a key focus, with platforms now required to disclose borrower risks and portfolio performance on a monthly basis, including information on non-performing assets (NPAs). This allows lenders to make more informed decisions based on up-to-date data.
7. Risk Acknowledgement: Lenders must sign a declaration that they fully understand the risks involved, including the possibility of losing their entire principal. This step ensures that lenders are fully informed of the risks before committing their funds.
8. Pricing Transparency: Platforms must disclose all fees upfront, whether as fixed amounts or as a percentage of the loan amount. This transparency in fee structures helps to prevent hidden charges and allows borrowers to clearly understand the cost of using the platform.

Why LenDenClub is Your Trusted P2P Platform

If you’re a borrower seeking financing or a lender looking to support that borrower while earning a return, LenDenClub is the P2P platform for you. LenDenClub is India’s leading P2P lending platform and is fully compliant with all RBI regulations. With a track record of 1.5 + crore trusted customers, LenDenClub offers both borrowers and lenders a safe, flexible, and transparent platform.