By Mark E. Battersby / Published September 2016
Small-business lending is becoming a big business, with hundreds of millions of dollars raised from unique “platforms” such as crowdfunding, peer-to-peer lending, and marketplace lending. How can a pressure cleaning business take advantage of these speedy financing options while avoiding the risks associated with borrowing from so-called “shadow banks”?
Crowdfunding employs an online platform to raise small amounts of money for a project or venture from a large number of people and only recently entered the equity arena. Peer-to-peer lending is the practice of matching borrowers and lenders through other online platforms, and while the newer “marketplace” funding remains undefined, it encompasses lenders that make loans to higher-risk, lower income borrowers as well as micro-financing and larger-scale financing for consumers and small businesses.
The entire lending marketplace is an emerging segment of the financial services industry that increasingly uses online platforms to lend directly or indirectly to consumers and small businesses. Borrowers are able to gain access to funds quickly and typically at lower interest rates than many banks offer, making it an attractive loan alternative for many borrowers.
Crowdfunding “platforms” are most commonly known for their use by charities, non-profits, and even a few entrepreneurs to raise money for worthy causes and special projects. Popular platforms include Kickstarter, Indiegogo, and Crowdrise that provide reward crowdfunding and, more recently, equity crowdfunding and debt crowdfunding.
Today, however, crowdfunding is challenging venture capital and angel funding as an alternative source of financing for many small pressure washing businesses. Equity-based platforms provide backers with shares of the business in exchange for the money pledged. In fact, thanks to the Jumpstart Our Business Startups (JOBS) Act of 2012, small businesses can now raise more funds from small investors with fewer restrictions, creating more interest in crowdfunding.
Early-stage businesses can pitch an idea, and ordinary people as well as wealthy investors (sometimes hundreds) can donate small amounts of money to the project. In exchange, the business owner offers donors some small incentive (e.g., free t-shirt with the company logo) or a larger benefit (e.g., equity in the company). Kick-starter and Circle Up are popular crowdfunding companies.
The new Securities and Exchange Commission (SEC) rules allow pressure cleaning businesses and even first-time start-ups to raise up to $1 million online from non-accredited investors over 12 months. The compliance usually required in private fundraising is waived although borrowers must provide financial statements—statements that don’t have to be audited.
The amount that an investor can invest will depend on the investor’s income. According to the SEC, an investor with an annual income and net worth of less than $100,000, can invest $2,000 or five percent of their net worth, whichever is greater, during a 12-month period. An investor with annual income or a net worth equal to or more than $100,000 can invest 10 percent of their annual income or net worth, whichever is greater.
The crowdfunding sites, not the pressure cleaning business, must be registered with both the SEC and the Financial Industry Regulatory Authority (FINRA). Debt crowdfunding and borrowing from individuals and other organizations have also grown rapidly and moved into their own category, often referred to as peer-to-peer (P2P) lending.
As borrowers seek alternatives to traditional bank lending, so-called “peer-to-peer” or P2P lending is growing rapidly. Much like crowdfunding, P2P lending matches borrowers and lenders through an online platform. P2P borrowers are able to gain access to funds quickly and often at lower interest rates than banks.
The loans issued are comprised of funds from many different investors ranging from individuals to institutional investors. P2P lenders underwrite borrowers but don’t fund the loans directly—they’re an intermediary between the borrowing pressure washing business and institutional investors, such as hedge funds and investment banks. Those third-party investors can invest in the loans on online P2P marketplaces, and they take on the investment risk, not the P2P lenders.
Individual and professional investors benefit by being able to lend money at a range of interest rates based on proprietary credit scores assigned by each platform. Since investors typically fund only a portion of a loan and spread the amount they loan across many borrowers, investors can potentially receive steady, attractive returns with the risk spread among multiple borrowers.
As a borrower, the pressure cleaning business only interacts with the P2P lender. After investors agree to fund the loan, the P2P lender transfers the total loan amount into the borrower’s bank account. The business/borrower repays the P2P lender, and they deal with repaying the investors.
Unfortunately, even though it may be the most innovative source of funding, P2P lending is definitely not the most affordable. Admittedly, banks take a lot longer to issue loans than P2P sites, but a business that can wait and that can qualify for a traditional bank loan or an SBA loan, will find that to be a far less expensive option.
As a more diversified set of investors, especially institutional investors, becomes involved on lending platforms, “marketplace lending” is a term often used to describe this growing industry. Online marketplace lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend to small businesses and consumers. While the volume is tiny in comparison with traditional bank lending, marketplace lending is experiencing rapid growth, with new lenders originating more than $12 billion in loans.
Marketplace lenders often employ new, largely automated underwriting processes. Some lenders purport to rely on “big data” not evaluated as part of traditional bank underwriting processes. However, there has yet to be one consistent, concise definition of what marketplace lending truly means. The U.S Treasury has issued a rather broad definition for the “marketplace lending,” stating that it is “the segment of the financial services industry that uses investment capital and data-driven online platforms to lend either directly or indirectly to small businesses and consumers.” They go on to say, “Companies operating in this industry tend to fall into three general categories: (1) balance sheet lenders, (2) online platforms (formerly known as ‘peer-to-peer’ or ‘P2P’), and (3) bank-affiliated online lenders.”
In general, marketplace lenders can be described concisely in three parts: a non-banking financial institution that employs heavily leveraged technology to drive simplicity and speed of process and serves a two-sided market of consumers and investors.
The majority of alternative online lenders lack a brick and mortar presence with which to interact with their customers, making it important for borrowers to spend time differentiating models. Each type of marketplace lender has a differing business model, with varying revenue streams and diverse motivations in serving their customers.
Marketplace lenders are currently required to comply with federal consumer financial protection laws, such as the Truth in Lending Act, Equal Credit Opportunity Act, Fair Debt Collection Practices Act, and Gramm-Leach-Bliley Act. Peer-to-peer lenders that fund loans through third-party investors, rather than from their own balance sheets, may also be subject to securities regulation.
For the most part, marketplace lenders are not usually subject to comprehensive federal or state supervision and examination in the same way as are banks and other insured depository institutions, nor are they subject to safety and soundness regulations, including minimum capital and liquidity requirements, under federal law.
Many marketplace lenders rely on banks to originate loans and merely purchase those loans for resale to platform investors. Therefore, for these lenders, a borrower may indirectly receive the same regulatory protections as any bank customer. In addition, a marketplace lender that acts as a service provider to one or more banks may be examined by bank regulatory agencies in connection with the services provided to the bank.
Although bank loans continue to dominate the financing space for small and mid-size businesses in need of capital, alternative funding sources are growing fast. However, it is important to keep in mind that these new entities are generally not government regulated in the way banks are. While it creates potentially more risk, it also makes them potentially more nimble, enables them to operate with lower costs by not having to meet a bank’s compliance and regulatory requirements, and allows them to innovate with technology.
Crowdfunding, peer-to-peer loans, and the closely-related and difficult to define marketplace loans may offer a less expensive source for the funds needed by a pressure cleaning business as well as faster results than funding from a more conventional bank or financial institution. Regulation and oversight of these alternative funding sources remain a concern for investors, although both are on the upswing. Deciding which alternative will benefit your pressure cleaning business and be less costly may require the services of a loan broker or other qualified professional. At the very least, all options should be thoroughly researched on the Internet before they are utilized.
Will your pressure cleaning business benefit from the alternative funding available from these online lending platforms?