In the entrepreneurial world, knowing how to start a peer to peer lending business [P2P lending] is one of the most critical skill sets you can have. Since the Great Recession of 2008, banks have tightened their purse strings when it comes to capital lending. This has forced small business owners to look for funding alternatives that they can use to meet their liquid cash needs without putting any of the equity in their business at risk.
Sometimes P2P lending is referred to as social lending or it gets grouped into a crowdfunding category. It is important to remember one thing: this is still a loan product that is being offered. Your P2P lending business will be financing private loans to small businesses or individuals who need cash now. Here’s what you need to do to get started.
1. Know your credit history.
You might be checking up on the credit history of people who are applying for your lending products in the future, but it is your credit score that plays a role in how your business gets started. Unless you’ve got a large pile of cash just sitting around somewhere, you’re not going to have the funds to make a lot of private loans at first. This means you’ll need to raise funds for your P2P lending business. Your credit score can influence the amount you can raise.
2. Secure a viable platform.
For some P2P lenders, setting up shop in a home office that stays offline makes a lot of sense. This helps their local community grow and they can make a profit while doing it. Most entrepreneurs, however, are going to want to start a website that will help them secure applicants and automate the screening process. This is important because you don’t want to be lending money to high-risk individuals who may default on the loan.
3. Give people the chance to make a pitch.
Because you’re going to be the one pulling the strings on the loans, it is important to allow people to make a pitch to you about their funding needs. A simple written essay about how the funds are going to be used and the expectations on when the loan will be paid back is often enough to tell if a loan is justified or not. A history of profitability and P2P loan repayment in the past are clear indicators that someone is a lower risk than other potential borrowers.
4. You can make money from more than just loan interest.
P2P lending involves a number of different borrowing fees, just like you can find at a traditional bank. You’re going to be likely offering a number of different loan products, so each can have a different fee structure. Look at closing costs, insufficient funds fees, late fees, and other places for added profitability, but make sure you’re not charging more than banks because you’ll lose some customers if you do.
5. Make sure that every loan has clear and precise terms.
You don’t want to leave any legal loopholes for your clients to maneuver through when it comes to your loan products. Make sure all of the repayment terms, the fees, and the penalties are all laid out in black and white so that there is no question of your expectations. Encourage questions, give precise answers, and hold your customers to the agreement without compromise.
6. Seek out lending partners for a wide variety of products.
If you’re looking to start a comprehensive peer to peer lending business, then consider finding partners that will help to provide additional loan products as well. One of the unique aspects of P2P lending is that some businesses allow “reverse bidding” on the interest rates of those who have been approved for a loan. An opening bid might be a $10,000 loan at 18%. Other lenders could offer an interest rate of 6%. It’s then up to the borrower to agree to the final terms or leave the offer on the table because it has been deemed to be not good enough.
7. Realize that all of your potential borrowers have already been classified as “high risk.”
Although the concept of relying upon one another for financing is done in the spirit of community cooperation, one fact cannot be removed from this equation: many people come to a P2P lending platform because they’ve already been denied by a traditional financial institution. This means that a vast majority of your potential clients, if not all of them, are going to be classified as a high risk investment. High risks can be higher rewards, but they can also mean losing that pile of cash you’ve built to get this business opportunity off the ground.
8. Secure your presence.
Once you’ve setup the foundations of your business, it’s time to give it a name and a secure presence. If you’re creating an online P2P lending site, then make sure you’ve secured the domain name. You may need to secure a name with your local jurisdiction as well. Then you’re ready to get to work building up the user experience of your site or business location to make it an attractive place for potential lending.
9. Have legal counsel on retainer before you initiate your first loan.
In a perfect world, everyone would pay back their loans. As the US government has found out with student loans [20% of which are in default], that just isn’t always the case. You may need to file legal actions against a borrower quickly to recoup losses. Having an attorney you can approach in an instant to begin this process can help you keep your pile of lending cash safe for future borrowers and income opportunities.
Knowing how to start a peer to peer lending business may not be easy and there may be financial hurdles that you’ll face, but it can also be extremely rewarding. Consider these tips as you get started and you may just begin a business that secures your own financial future in addition to the small businesses that you will help.