Preparing for Entrepreneurship – Establishing Operating Capital for Business Longevity – Week 2

In today’s financial climate, we as Americans have put aside the age-old adage of “Neither a borrower nor a lender be,” preferring instead to make the most out of our opportunities – and when there are none directly in front of us, preferring to create our own opportunities.  In case you missed last week’s blog, this month’s series focuses on alternative funding options for aspiring entrepreneurs; today’s, specifically, is on the recently developed peer-to-peer lending system.

Week 2: Peer-to-Peer Lending

Peer-to-peer lending, or social lending, removes the traditional financial institution from the lending process (known as disintermediation) and directly connects people who need money with people who have money to invest.  The loan works as a traditional loan, with a set interest rate and a period of repayment, so peer-to-peer lending from an investor’s standpoint is considered a for-profit activity, but with a greater amount of flexibility for both borrowers and lenders.

What differentiates peer-to-peer lending from other types (say, borrowing directly from a friend or family member) is the starring role the Internet plays – specifically, social networking.  The biggest assumption peer-to-peer lending works off of is that people will be less likely to default on their loans if there somehow exists a personal connection.  It’s a shrewd capitalization on a person’s innate sense of honor, magnified by personal connection, whether that connection is based off mutual community, existing personal relationships, mutual interest, or geography.

Arriving in the U.S. in 2006, peer-to-peer lending began picking up its pace in 2007, its main known advantage is its ability to lend out with minimal interest rates, usually under ten percent.  Unfortunately, that major point of attraction is beginning to gradually fade out with the sheer volume of people beginning to turn to this innovative lending method – making now the optimum time to use it if you’ve been considering it, before it fades into yet another financial institution little different from the ones already in existence.  The most well known peer-to-peer firms are Zopa, Prosper and Lending Club, all of which have undergone their fair share of both criticism and praise.  As a potential investor, one of the risks of offering your backing is put very eloquently in an article by Mark Gimein, business writer for the New York Times:  “ultimately a paradox of lending is that the people who are more likely to repay are those who don’t need the money.”

Have you found social lending to be practical?  Or is it more of an ideal?  What other alternative lending methods have you found to be successful?