A couple of other types of “loans” have become available that may be attractive as a source of startup capital.
Peer to Peer (P2P) Lending
Peer to peer lending is a mechanism for a peer to peer platform or lender to “underwrite” or vet the proposed borrower and serve as an intermediary, while the actual funding is provided by individuals or institutional investors such as a hedge fund or investment bank. There are platforms that cater to individual borrowers and others which cater to businesses and a few that lend to both.
Peer to peer lending platforms generally caters to businesses with established (and good) credit as credit worthiness is part of the underwriting process. However, it can generally be easier to get a loan from a peer to peer lender than from a traditional bank. It is important to note that collateral or a guarantor (i.e. personal guarantee) may be required based on loan size, credit score etc. This means that some of the same issues that affect traditional bank loans are also at play in P2P Lending.
The range of annual minimum revenue, business credit scores, loan size, loan type, and interest rates vary by platform. Three well regarded P2P platforms for business loans are Funding Circle, Lending Club, and StreetShares which are used as examples. Below is a brief description of each platform as well as an overview of the P2P borrowing process.
Funding Circle (FundingCircle.com)
Funding Circle claims to have helped over 40,000 small businesses across the world with the support of 71,000 investors from around the world. They are focused on growth businesses, do not require a minimum annual revenue, although they claim to have the highest required minimum credit score (620) and offer larger loans of $25,000 to $500,000. According to their website, interest rates start at 4.99 percent, however the more likely range is an APR ranging from 10.91% to 35.5%. There are no prepayment penalties and loan terms ranging from 6 months to 5 years. Like many platforms and banks, Funding Circle makes their revenue from origination fees.
Lending Club (LendingClub.com)
Lending Club offers loans of $5,000 to $300,000 for business expenses for terms ranging from 1-5 years as long as your business has an annual revenue of at least $50,000 and good business credit. No collateral is required for loans under $100,000 and the platform does not require a business plan, appraisal or title insurance. Interest APR’s range from 9.8% to 35.7%. It is considered a “premier” P2P lending platform with issued loans of over $28 billion (total) and is a public company.
StreetShares is a veteran founded and veteran run business that funds loans to Veteran and main street businesses across the United states in a diversified portfolio. StreetShares requires applicants to be a U.S. resident whose business has been up and running for at least 1 year. Term loans of 3 to 36 months range up to $250,000 and to qualify you must be a U.S. resident, be in business for at least one year, and earn a minimum revenue of an estimated $75,000 per year, with a loan funding cap of 20% of revenue. APR’s range from 9% to 40% and a “business guarantor” is required. StreetShares also offers lines of credit and other loan types.
What is the application process for a peer to peer lending platform? Although processes vary, below is a summary of key steps to expect.
Loan application steps
• Initial (online) questionnaire: The platform does an initial credit review (not a formal credit check) and your credit worthiness is assessed.
• Loan Request: The platform will share your loan request with their group of investors (details varies by platform) who will indicate interest in your loan at the indicated interest rate (based on credit level)
• Investor Interest: If/when sufficient investors are interested, the loan is eligible for funding.
• Follow up Documentation Requested: Income, employment, list of existing debts (in refinancing and debt consolidation) etc must be documented to the satisfaction of the platform.
• Formal Application Review: This is equivalent to a bank underwriting process to ensure documentation matches your initial questionnaire claims. At this point, either more documentation will be requested or your package will be approved to move forward to funding
• Funding Approved – Once again, documentation is a big deal, and loan documents (including liens/collateralization) will be sent to you for signing. Funds will be wired to your account after receipt of signed package.
• Some sites claim “1 day”, but most acknowledge it takes at least 1 week, perhaps longer depending upon your degree of preparation and having all the needed documents
Revenue-based financing – RBF – (sometimes referred to as royalty-based financing)
Revenue-based financing was originally pioneered in the energy industry, but today it has expanded to a wide variety of entrepreneurial ventures and is a mechanism where flexible business loans are repaid as a percentage of future revenue receipts. Successful RBF requires two attributes of the borrowing company – first that it is revenue generating with a stable and growing recurring revenue stream, and second the business must have meaningful gross margins to permit loan payments while funding business growth. RBF is not suited to startups, but rather to existing firms with Software as a Service (SaaS) and other recurring monthly revenue firms being particularly attractive.
In general RBF platforms can fund loans ranging from $50,000 to $3 million dollars, without requiring equity (non-dilutive), or a board seat. Loans can often grow because the repayment is flexible as it is a percentage of revenue, usually ranging from 2% to 10% of revenue. RBF loans are designed for revenue growth initiatives such as product development, sales and marketing efforts and new employees. Loan repayment can be expected to total 1.35 times to 3 times the original loan amount with the resulting effective annual interest rates ranging up to 30%. Loan origination fees vary.
A business plan similar to that needed for traditional angel and VC investors is required and one estimate is that the plan should show 10x revenue growth during the loan repayment period. In general personal guarantees and collateral are not required, but of course due diligence is required.
One newer platform that focused on RBF for a variety of business is Lighter Capital (https://lightercapital.com/) which has partnered with Silicon Valley Bank to provide cost effective startup banking services to Lighter Capital clients.
A second RBF platform is GSD Capital (https://gsdcapital.vc/ ) which is focused on non-dilutive funding for emerging SaaS companies. Scaleworks (https://scaleworks.com/venture-finance/ ) is a firm that refers to (part of) their model as Venture Finance, but because of their exclusive focus on SaaS and recurring revenue should be considered an RBF firm.
Another platform, ClearBanc (https://clearbanc.com/) refers to their business model as “marketing focused funding” but it a variant of RBF where the proceeds are limited to use to fund digital marketing campaigns only for eCommerce and Consumer SaaS (software as a service). They claim to use business data for loan approval, but do mention that a business with multiple partners will have all the partners “verified” before a loan can be approved, so it is not clear whether personal credit or personal guarantees are required. According to Clearbanc, minimum eligibility criteria includes an average monthly revenue of at least $10,000 with at least 6 months of consistent revenue history. A borrowing company agrees to a flat fee, for example 9% of the loan amount, with a fixed repayment amount, typically 1% to 35% of future revenue, being agreed upon.
For businesses with a (continuously growing) recurring revenue or SaaS business model, revenue based financing can be an good opportunity to borrow money at reasonable terms for specific growth oriented purposes. However it is not viable for businesses outside this narrow range of business models.
Factoring, or invoice factoring, is a longstanding method to raise short term cash by selling accounts receivable to a third party called a factor. Typically the factor buys the accounts receivable with a discount of 2 to 6%. Usually the factor will pay around 75% of the invoice(s) up front and then pay the remainder once they have collected the entire amount. Amounts can range from a few 10’s of thousands of dollars to millions depending upon the business and the size of its accounts receivable. The credit worthiness of your customers is the key determinant!
This model is useful for companies with large accounts receivable where the customer has a long lead time for payment. However, in many businesses, factoring can give up a sizable percentage of the company’s profits.