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Note: This article was originally written in 2012 by Gregg Schoenberg and has been updated by the HBS editorial staff as of October 2019.
After the global financial crisis of 2008, one area of the economy that was slow to fully recover was the small-business loan market. Because large banks dealt with the economic fallout, and trying to reduce the size of their loan portfolios, most of them were only interested in lending money to their biggest, most creditworthy clients.
In a situation such as this, where is an entrepreneur to go when in need of a business loan? One answer may be to look to the world of peer-to-peer (P2P) lending.
The premise and business model of P2P is fairly simple: People lend money to one another and to small businesses via the Internet. Both sides benefit by cutting out the costly middleman—the bank—and borrowers wind up with more affordable loans while lenders get a higher rate of return than they would from parking their money in a savings or money-market account.
P2P lending got its start in the early 2000s and grew significantly during the financial crisis as bank lending all but stopped when the global economy seized up. And it got a big boost of legitimacy when John Mack, the former Chairman of Morgan Stanley, one of the world’s largest investment banks, joined the board of the P2P firm, Lending Club.
If you are interested in obtaining a P2P loan, it’s easy to get started:
If the P2P company approves you as a loan candidate, they will assign you a credit rating based on your credit history and financial situation. The more creditworthy you are deemed, the higher your rating will be and the lower the interest rate you’ll wind up paying. The P2P firm then places the details of your loan request on its online platform where lenders look for investment opportunities that fit their risk and return profiles. There is no guarantee that your loan will get funded, but if it does, you’ll receive the money in a timely fashion and be required to pay it back in fixed monthly installments.
One of the keys to passing muster with any lender, be it a bank or a P2P firm, is to maintain an outstanding credit score so be sure to do everything possible to boost your score before applying for a loan.
And whether or not you’ve had trouble obtaining bank loans for your business, it may be worthwhile to look into the possibility of obtaining P2P financing. While the traditional banking industry shrank after the recession, P2P lending grew, meaning that both borrowers and lenders saw it as a valuable platform to help meet their financing and investing needs.
According to FitSmallBusiness, the top P2P Lending Firms of the year are:
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.