The Complete Guide to Crowd funding and P2P Lending by T.M.Hoy For most businesses, banks do a lousy job of providing the capital they need to operate. More businesses borrowed money from their suppliers last year ($2.15 Trillion) than they did from banks ($1.5 Trillion). As another example, of the 27.5 million companies in the United States, venture capitalists funded about 3800 of them last year, or less than 2/10's of a percent. Thus a huge number of companies do without the capital they need, or operate with insufficient capital. Consequently, small businesses have had to get creative with financing, and one new method that has become extraordinarily popular is the field known as crowd funding. Also known as crowd financing, equity crowd funding, and variations on the term peer-to-peer lending (P2P), this phenomenon involves individuals pooling their funds through the Internet to support the efforts of others. There are actually three separate kinds of lending going on here. Crowd funding is of two main types: rewards-based crowd funding, and charity crowd funding. Peer to peer lending on the other hand, while sharing many similarities with crowd funding, puts the borrower in much closer contact with the individual lender, whereas crowd funding tends to be for smaller individual amounts with lenders kept at arms length. We'll deal with each of these varieties in turn. Charity crowd funding is fairly simple. Using a “crowd funding platform” or website devoted to connecting lenders with borrowers, people that support a particular kind of activity can donate directly to causes they wish to help. This can include disaster relief, funding for start ups, political work, and the entire broad range of activity engaged in by nonprofits. Usually there is no quid pro quo, and the effectiveness of the charity's fundraising efforts depend on how good their media presentation is on the crowd funding website. Rewards-based crowd funding, on the other hand, seeks contributions in exchange for future goods or services. Normally this is not actual repayment, but goodies offered as an incentive to supporters. This includes things like T-shirts, a copy or copies of the product, acknowledgment (which may include having a vote or say in design, and on project decisions), vouchers or points awarded that are redeemable for prizes later, and even simple thank you's. On the two major rewards-based crowd funding sites –www.Kickstarter.com and www.Indiegogo.com, the money collected from “investors”is never repaid. If the goal set by the project founders for donations is not met then all funds are returned to those that donated them. But if the goal is met or exceeded, the funds go to the project managers, and no repayment is expected – except for fulfilling whatever promises were made to entice people into donating on the site. Sometimes this works very well. A watchmaking company – Pebble, managed to raise several million dollars (they set a goal of $100K) – and simultaneously found their target market ! These kind of sites are good for businesses and people engaged in the arts (such as in music, movies, art projects, and so on), for small businesses interested in testing products, and for charity groups and causes of all kinds. Since most banks and lenders don't fund startups or small businesses without a track record, private equity and formal capital borrowing are out of reach for the vast majority of businesses – over 99%. Most business owners are forced to tap family and friends for money, use their savings, and take out personal loans, lines of credit, borrow against retirement accounts and so forth. Crowd funding circumvents all this and reaches out directly to people with money to lend. Since crowd funding isn't really designed for your average small business (after all, designing a media campaign that will get people excited about a corner store or auto parts place is difficult to imagine), peer-to-peer
lending has emerged as a very similar alternative. In peer-to-peer lending, various kinds of websites attract investors with higher interest rates than they could earn from traditional investments, and match them up with businesses needing capital. These online platforms all fall under the rubric of “crowd funding”, but differ substantially from either charity based or reward based varieties, in that both principal and interest on the principal are repaid just like any normal loan. P2P sites invite borrowers to tell their story, emphasizing that it needs to be compelling. The borrower needs to describe why they need the money, how they'll spend it, how they'll repay it, and whatever other details can be provided that will attract lenders. These sites pull then display the borrower's credit history, set an interest rate and invite lenders to bid. The site posts the borrower's loan request, and if lenders like it, cash is pooled together, which is then forwarded to the borrower. The P2P site monitors the loan; collects the monthly payments, and distributes funds to lenders. The business owner gets the capital they need, lenders get a better return on their capital, and riskier loans get funded than if banks were approached. Typically, P2P loans are unsecured, generally have repayment plans of less than 60 months, are fairly simple and fast, require little documentation, and are usually small (i.e. less than $25,000). P2P sites make their money through origination fees, usually 2 to 5% depending on the credit risk, and this may be included in the interest rate borrowers pay – for example, an extra .25% added to the rate. The sites also typically charge failed or rejected payment fees, late payment fees, and fees for borrowers paying by check. There are two giants in the field; www.LendingClub.com, and www.Prosper.com. Lending Club has made over $2 billion in loans to date, and has worked hard to bring peer-to-peer lending into the mainstream. They have created a secondary market for lenders to buy and sell loans (called FOLIOfn), and have three classes of credit risk: A = (currently 5.47%); B = (currently 8.87%); C = (currently 10.22%). They make it easy for lenders to create a 'portfolio' of loans, and make the entire process easy to use and to understand. Prosper runs a distant second, with over $500 million in loans issued. They offer better returns than Lending Club – but by taking on greater risk. Their rates vary from 6.73% up to 35.36%. Both sites have very large memberships, with over 1 million members apiece. Lending Club requires a minimum credit score of 660 (by borrowers) to apply, Prosper requires a minimum credit score of 640. Lending Club will loan up to $35,000: Prosper lends from $2000-$35,000. There are many other P2P sites that vary considerably in quality, and in their credit standards. Some of the larger ones include www.SoMoLend.com, which advertises loans from $100-$100 million (they follow the standard P2P format for borrowers of creating a profile and a loan application, allowing borrowers to review loan offers, and giving lenders an opportunity to evaluate profiles and choose who they wish to fund); www.OnDeck.com, which lends from $5000 up to $250,000, and promises a decision on a loan in minutes and cash in a day (loans under $25,000 can be made in under an hour) - On Deck is a little more flexible than most lenders in that they check out your cash flow and business performance, not just your credit history, lending terms may extend as long as 3 to 18 months; www.Kabbage.com which promises loans to SME's within 7 min. (they have a debt facility of $75 million), www.SeedInvest.com, www.EnduranceLendingNetwork.com – loaning from $10,000 up to $500,000 within 14 days at a set rate of 10.99%; www.99Funding.com; www.Biz2Credit.com; www.Zopa.com (in the U.K.); www.EasyPay.com, and – the latest entrant, www.Dealstruck.com, started in June, lending between $100,000-$1 million with rates from 5 to 15%.
There are also variations on this theme, such as those specializing in student loans, like www.Vittana.com, a nonprofit based in Seattle, making microloans to students. www.PeopleCapital fulfills a similar function matching students with lenders. Along similar lines is www.UnitedProsperity, a microcredit organization that makes loans as guarantees to banks, and works in extreme poverty areas in the developing world. It is more like a charity-based crowd funder, though these are structured as loans. Another twist on this theme are ways to formalize loans made by family and friends. This includes www.LendingKarma.com, a Better Business Bureau accredited San Francisco company that offers ways to formalize informal loans, and www.Wikiloan.com, which offers tools and templates for forms for loans between $500-$25,000 made between friends and family. www.VirginMoney does the same thing and makes social borrowing official. But this is all very early days for crowd funding. The entire field is about to expand radically. Thanks to the JOBS Act (the Jumpstart Our Business Start-ups Act), signed by Pres. Obama in April of last year, small businesses will be allowed to raise money by selling stock directly to investors through crowd funding platforms without registering with the SEC. Previously there was a ban on ads for sale of stock to the public. The jobs act lifts this ban for equity crowd funding. Whereas before SEC registration was required and only accredited investors could invest (an “accredited investor” by SEC standards is an individual earning over $200,000 per year, with a net worth exceeding $1 million), now small companies won't trigger the requirement to file with the SEC until over 500 non-accredited investors or 2000 total investors have been reached. Thus, a company can sell up to $1 million in common stock to up to 1999 people without having to go public. To protect non-accredited investors, a limit has been set on contributions restricting investment to 2% of someone's annual earnings, or to an investment of 10% their net worth (up to a total of $40,000 per investor), so that someone earning $100,000 a year is limited to investing $10,000. This is to prevent someone from making a foolish decision out of greed or excitement and losing their life savings. Many regulators within the SEC are less than thrilled with this change. They have dragged their feet, and have delayed implementing the rules, thus keeping the jobs act from actually going into effect. However, strong Republican support and insistence demands from the business community have prodded the SEC to the point where full implementation is likely by September or October of 2013. You can receive regular updates by visiting the SEC website at www.SEC.gov. FINRA (the financial industry regulatory Association) has been less resistant to crowd funding (though they are in fact a part of the SEC). They recently started the crowd fund intermediary regulatory advocates (CFIRA) and a sister organization, the crowd funding professional Association (CfPA), both designed on financial industry self policing organizations, encouraging members to maintain certain standards. FINRA has established a registration process inquiry form for crowd funding portals, and is in the process of creating rules by which crowd funding sites will operate. Developments are occurring fast and furious. One of the founders of crowd funding, who helped push the JOBS Act through – Michelle Goodman, estimates that crowd funding will be a $4 billion market once the SEC's rules are implemented. Freeman White, CEO and cofounder of Launcht.com - a company that creates crowd funding platforms for universities, nonprofits, incubators, and business plan competitions, believes it could quickly grow to 10 times that size. Whatever the actual figure, the future of crowd funding looks secure, and growth will almost assuredly be swift. Some excellent sites to keep abreast of news in this field include www.crowdfundinsider.com, www.thenewentrepreneur.com, www.paymentnews.com and www.P2Plendingnews.com.
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