Perfect strangers | Small businesses turn to online social lending for financing
Photo/David A. Rodgers
Tom Shepard, a financial planner, used Prosper.com to help finance his Yarmouth business
Tom Shepard is a certified financial planner. So, he was well informed of his options when he needed a $25,000 loan to expand his Yarmouth business. But rather than turn to a bank, Shepard asked a bunch of people he’d never met. He submitted a loan request to Prosper.com, a social lending website that is to financing what match.com is to romance. Under the screen name “personalpe,” Shepard posted his loan request, complete with a family photo and details of his financial situation. Hundreds of lenders on the site chipped in $50 here and $100 there, and two days later the loan was fully funded. “I didn’t want to ask family or friends,” he says. “So I asked strangers instead.”
The concept behind social lending sites like Prosper is that borrowers can get loans that banks won’t touch or find better rates than traditional lending institutions offer. Lenders can earn higher returns — sometimes upwards of 30% — than from a savings account, and manage risk by diversifying among dozens of loans. The sites charge fees to broker and service the loans — 2% to 4% for borrowers and about 1% for lenders — and penalties for late payments cover the cost of hounding delinquents. The “peer-to-peer” lending market remains a small piece of the nation’s financing pie, but it has caught bankers’ attention. The dollar amount of outstanding loans jumped 41.7% in 2008 to $102 million, according Seattle-based NetBanker, which tracks the online finance world, Forbes recently reported. With credit in a vice grip, peer-to-peer lending seems poised for further growth, but regulatory crackdowns have slowed its momentum.
Prosper, the largest and oldest auction-style operator, boasts more than $178 million in funded loans since its 2006 launch. Maine borrowers currently list about 115 loans totaling $565,708 on the site, according to LendingStats, which tracks Prosper activity. Some of the loans are listed more than once, and debt consolidation requests make up the bulk. Roughly 15 loans in Maine are listed for small business and entrepreneurial purposes, with titles including “Van for growing flower shop,” “Expanding my small business” and “Downtown Bangor Reiki center.” Prosper loans max out at $25,000, so requests from businesses with more than a few employees are rare. The average loan rate in Maine is 16.17%, compared with 18.12% nationally, according to LendingStats.
Borrowers post the amount of money they need, the purpose of the loan and the interest rate they seek. Lenders then bid on the loans, offering increasingly attractive interest rates and typically funding fractions of dozens or hundreds of loans. Lenders evaluate risk based on the borrower’s credit score, a letter grade assigned by Prosper. The site also verifies borrower’s identities. All loans are unsecured at a fixed rate for a three-year term.
Online social lending has yet to catch on in Maine’s lending community, however. Chris Pinkham, president of the Maine Association of Community Banks, says he’s “barely familiar” with the phenomenon. Such sites are likely to gain traction, however, as business owners pursue more creative financing avenues, according to Mark Delisle, state director of the Maine Small Business Development Centers. “A lot of those alternative financing paths are going to start becoming more popular considering how difficult it is to go through the traditional routes,” he says. At Coastal Enterprises Inc. of Wiscasset, online peer-to-peer lending has popped up on the radar screen, if only anecdotally. “We have a sense that it’s happening, but the amount or the number of groups, it’s hard to give an estimate,” says business counselor John Scribner. Social lending does occur more informally in Maine, such as among a network of Somali women in Lewiston who contribute money to a central pool, he says.
Financial planner Shepard of Yarmouth says he would consider directing clients to sites like Prosper, if those sites can overcome regulatory hurdles. In November, the Securities and Exchange Commission served Prosper a cease-and-desist order, saying the site was essentially selling unregistered securities. The site is now registering as a securities broker, and is not accepting new lenders or loans. Other social lending sites have encountered similar regulatory roadblocks.
Shepard’s experience with the site was “a piece of cake,” he says. Under the listing “Family grows, business must too,” Shepard posted a picture of his family, complete with new baby, and requested a $25,000 loan to buy a partial practice to add to his business. He didn’t have a sufficient track record as an independent business owner to get financed through a bank. “I had an opportunity,” Shepard says. “You could have charged me 25% and I still would have pursued the opportunity.” Rated a grade “A” borrower, he wound up paying an 11.5% interest rate and attracted 656 bids.
As it turns out, one of those bidders lives about a half-hour’s drive away. Rich MacLaughlin of Windham funded $100 of Shepard’s loan, earning 11.5% in interest. As a “hobby,” he’s invested $2,000 to $3,000 on the site among about 60 loans. It’s a fun alternative, he says, to his day job — an assistant branch manager for a national commercial bank. “I deny a lot of people loans at the bank. From a banking perspective, that’s for good reason,” he says. But Prosper allows him to not only diversify risk, but also give people a leg up, such as a single mom trying to get back on her feet and a man caught in a cycle of payday loans, he says. “If you can ferret out the good loans throughout the country, you do have the ability to help some people and make some money,” MacLaughlin says.
About 60 people are making some money off of Joe Kaper, a business manager at Maine Floral Creations in Scarborough. He took out a $4,500 loan on Prosper, much of which has funded operating expenses, at a steep 34.95% interest rate. Efforts to get financing through the U.S. Small Business Administration, banks and credit unions fell flat, and he and his partner, shop owner Niki Martin, couldn’t get a credit card with a high enough limit, he says. While his lenders are making “guaranteed mint” on his loan, the funds contributed to the business, now in its third year of operation, Kaper says. “It’s brilliant. I wish there were more sites like that.”
Kaper has faithfully made payments, but desperate borrowers who can’t afford their loans have contributed to Prosper’s 16.83% national default rate. Maine’s rate is much lower, however, at 3.47%, according to LendingStats. The site maintains a reputation for safeguarding users’ private information and is licensed in Maine through the Office of Consumer Credit Regulation. The office has not received any consumer complaints about Prosper since it was licensed in September 2007, according to Director Will Lund.
Restaurant operator Kim Horton was suspicious of the site when she stumbled across it online. After a little research, though, she felt comfortable enough to take out a $10,000 loan at a 13% rate to make improvements at Bassa Cocina de Tapeo in Northeast Harbor, a tapas restaurant she co-owns. As a recently divorced woman just entering the restaurant business, banks wouldn’t give her a chance and took too long to respond, Horton says. “I was funded really quickly,” she says. “The interest rate was high but not unbearable, certainly not bad when you look at what American Express charges people right now.” Now preparing to open a third restaurant in Ellsworth, Horton says the banks take her more seriously these days. But she wouldn’t hesitate to use the site again in a pinch. “They helped me when I needed help.”
Jackie Farwell, Mainebiz staff reporter, can be reached at jfarwell@mainebiz.biz.
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