Why Small Businesses Are Not Yet Embracing P2P Lending and Crowdfunding
If you read business news, you might think that crowdfunding and peer2peer lending are very popular sources of business financing just by the volume of media coverage that they get. But P2P and crowdfunding platforms are relatively new to the lending space and make up a tiny fraction of business loans. Here, we explain how popular P2P loans and crowdfunding are compared to other sources of financing and why small businesses still haven’t warmed up that much to them.
Peer2Peer & Crowdfunding Lending In The Overall Loan Market
Peer2Peer lenders bring investors and borrowers together in an online platform. Borrowers say how much they need to borrow and provide some basic business information, and individual investors decide whether to fund the loan. P2P loans are like ordinary loans–they carry an interest rate and must be paid back within a certain time. Popular P2P lenders include Lending Club and Prosper.
While Peer2Peer lending is generally for established businesses, crowdfunding is more for startups. 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). Kickstarter and Circle Up are popular crowdfunding companies.
While these are certainly innovative ways for businesses to raise money, the great majority of small businesses don’t use P2P lending or crowdfunding. In a survey conducted by Manta, only 2 percent of small business owners reported using crowdfunding. Another poll from Gallup-Wells Fargo found that just 3 percent of small businesses used crowdfunding.
Why Don’t More Small Businesses Use P2P Lending and Crowdfunding?
- They’re hard to qualify for
Even though crowdfunding sites market themselves as being a go-to source of funding for startups, in reality only a few startup ideas are crowdfunded. CircleUp rejects 98 percent of startup applicants because they wouldn’t provide a good return on investment for investors. Another Crowdfunding site rejects “idea stage” companies and prefers more serious businesses.
If you are an existing business, Peer2Peer lenders can also be difficult to qualify for. Peer2Peer lenders require you to have a good credit score (600 or higher), and you should be in operation for at least 2 years.
Alternative lenders, like OnDeck, are actually easier to qualify for because they have lower credit score requirements (above 500), and you only have to be in business for 1 year.
- Peer2Peer lending can be costly
Even though it may be the most innovative source of funding, Peer2Peer lending is definitely not the most affordable. APRs for one popular Peer2Peer company, Lending Club, range from 14 % to 19 %. This is cheaper than alternative short-term lenders, but banks and SBA loans are significantly cheaper. Granted, banks take a lot longer to issue loans that Peer2Peer sites, but if you can wait and you can qualify for a traditional bank loan or an SBA loan, that will be the less expensive option.
In the Manta survey, many small businesses said that they didn’t use crowdfunding because they didn’t understand the technology or didn’t trust the service being provided. While this may certainly be stopping some small businesses from using crowdfunding or P2P lending, these sites actually aren’t difficult to use. Any business owner can create an account on Lending Club or Kickstarter and pitch their business idea or seek out a loan. I think the distrust stems from a lack of knowledge that crowdfunding and P2P lenders should address by doing a better job of reaching out to the small business community.
- Too many cooks?
One last reason why small businesses might not be successfully using crowdfunding or P2P lending is because famous ideas are crowding out the little guys. For example, director Spike Lee and actor Zach Braff have used Kickstarter to raise funds for their films! Some people believe this is fine because investors have the right to choose which project to support with their money, regardless of who is leading the project. On the other hand, some people argue that this destroys Kickstarter’s stated mission of bringing visibility to projects that otherwise wouldn’t get off the ground.
Crowdfunding and Peer2Peer lending have the potential to revolutionize the lending space if more businesses catch on to the trend. However, as of now, it still makes up a very small slice of the small business loan pie.
Experts believe controversial, political crowdfunding campaigns show no signs of slowing down.
By the next day, as cable news channels played footage from police body cameras that captured, in visceral detail, the shooting of the black suspect by the white officer, the popular crowdfunding site suspended the campaign with little comment or warning.
The site has now officially removed the campaign, saying it “did not meet their standards.” Not a single dollar was raised.
This wasn’t an isolated incident. Just a week ago, Indiegogo removed another campaign to raise cash to pay the legal bills of a white officer charged with murder in the killing of a black man, after a witness’ smartphone video of the shooting went viral. In that case, the campaign for now-former South Carolina police officer Michael Slager raised more than $1,300 of its projected $5,000 goal before it was taken down. GoFundMe, another crowdfunding site, removed a similar page supporting Slager.
A shift is happening. Crowdfunding sites are typically places where people seek public donations for projects ranging from paying medical bills to helping the homeless to starting up businesses to manufacturing a product. Some campaigns even invite donors to contribute in exchange for one of the finished products.
Now those same crowdfunding sites — whose reputations were built on helping musicians, artists and other people behind good causes raise money — are becoming new portals to fund people involved in controversial, emotionally charged issues.
It’s not just to help policemen accused in shootings. A campaign for a small-town Indiana pizzeria that publicly supported a controversial “religious freedom” law critics said was anti-gay took in more than $800,000 in crowdfunding — despite a national backlash. Similarly, a Washington state florist that was fined $1,000 for refusing to sell wedding flowers to a same-sex couple netted nearly $170,000 in crowdfunding.
Also, before the coast-to-coast outcry over the fatal shooting of Michael Brown, who was black, by white Ferguson, Mo., police officer Darren Wilson last summer, fund-raising pages were set up for both men. Wilson’s GoFundMe page even netted more than a quarter-million dollars before it was shut down without explanation.
It raises the question: Is every major polarizing issue now a cause worth crowdfunding?
“I think it was kind of inevitable that crowdfunding would be used to address more controversial, divisive issues,” said Rodrigo Davies, a crowdfunding researcher at Stanford University. “I’m not at all surprised. It was just a matter of time.”
However, Davies, who also is the head of product at the civic crowdfunding site Neighborhly, said what does surprise him is that Indiegogo and GoFundMe pulled the crowdfunding pages of the officers involved in the recent shootings, and that they did so without any rationale.
“They can’t just hold their hands up and say, ‘Hey, we’re just a host,'” Davies said. “What they have done now sets the tone for future campaigns.”
A GoFundMe spokeswoman declined to comment and an Indiegogo spokesman had no immediate comment.
Richard Swart, a researcher at the University of California, Berkeley who focuses on crowdfunding, has a similar point of view.
“I would’ve yanked them down, too,” Swart said, but that doesn’t mean the sites should have. “I think they were politically polarizing, and I don’t think crowdfunding is meant to create polarization.”
Swart said this hot-button type of crowdfunding has been happening in America for the past couple of years with no signs of letting up.
Both researchers say more politicized, niche crowdfunding sites will eventually sprout up.
“We’re just scratching the surface for sure,” Davies said. “Is there an issue you’re passionate about, and can we apply collaborative funding to it? Probably.”
At a recent international forum, this paper was discussed with global leaders, including the World Economic Forum, and crowdfunding is seen as a significant opportunity for increasing access to capital. In the US we talk about how the promise – not yet met – of crowdfunding is the democratization of access to capital for entrepreneurs. Globally, crowdfunding is seen as a mechanism for providing access to capital for a massive amount of the world’s population that remains outside of traditional banking and finance systems.
It is becoming widely accepted by policy makers and economists that most of our current developmental economic models are an abject failure. The “world order” of the IMF, World Bank, United Nations, etc., grew out of the Bretton Woods accords at the end of WWII. China is assertively challenging the hegemony of the US Dollar and the power of the World Bank. There have been meetings at the UN discussing whether the institution should be dissolved and a new institution take its place. Many respected economists accuse the IMF of predatory or abusive lending practices that serve to protect the economic interests of first world nations over the needs of the developing nations.