Peer-to-peer lending is the most common type of disruptive lending, typically providing cashflow lending rather than secured lending
With banks progressively moving away from small-business lending due the current economic climate, many SMEs are turning to alternatives to finance their business.
We’ve been flooded with ‘disrupters’ who have shaken up established business models including the rapid rise of Uber and Airbnb, inspiring others to take their lead.
Peer-to-peer (P2P) and other ‘fast cash’ lenders are one of the most recent trends disrupting the personal and business lending space, offering loans without the requirements that banks usually demand. If you don’t have a house title for security, banks will be extremely reluctant to lend, meaning most new start-ups simply aren’t able to access traditional finance.
For entrepreneurs looking to finance their business, disruptive lenders can be enticing given there is no need for capital to support their loan however, the dangers often outweigh the benefits.
What are disruptive lenders?
P2P lending is the most common type of disruptive lending, typically providing cashflow lending rather than the secured lending offered by the banks. This means they essentially take on the same risk with their loans without the security of assets – such as your house.
In the past, the big banks owned finance companies which would handle SME lending, and these companies were more open to risk and their interest rates reflected that. P2P lenders operate the same way.
What are the dangers?
Disruptive lenders pose a risk to borrowers because they cannot afford to work through cash flow issues if there is a problem and so will have to ‘pull the plug’ when loans fall into arrears. They simply don’t have the resources and skills to handle defaults other than to take a hard line.
Macquarie Bank in the 80s is one example of a large-scale cash flow lender. They actively sought real estate agencies by offering attractive loans, then simply exited the market and demanded borrowers refinance their loans when things turned sour.
Further, an SME in a growth phase simply can’t generate sufficient free cash to not only service the loan but also repay it over a relatively short period. As these lenders don’t require assets as security, they hike up their interest rates to cover the risk and, if your cash flow is struggling, you are simply compounding the problem.
What are alternatives?
If you require capital for short term purposes, such as funding a project, talk to you bank. They may be open to supporting you for a small loan with minimum fuss. If they knock you back, it’s probably for good reason; if your proposal is too risky for them, then it’s most likely too risky for you.
The best alternative is to seek out an angel investor or look for crowdfunding as an alternative to the banks. Angel investors will usually be experienced entrepreneurs themselves who are prepared to become a silent partner in your business, with mentoring and advisory skills. They may be difficult to find, however, given they will be putting their funds at risk, they will ensure you do the right thing so you both benefit. Of all disruptive finance models available, I believe this offers the most security for both parties.
Any loan to a new small business is high-risk and should preferably be handled by equity funding.
You need to be careful about having any debt within your business, and look to minimise it wherever possible. Your focus should be on running tight cash flow and growing from the cash it generates. This means negotiating longer credit terms with your suppliers and taking a tight line with your own customers.
