For many people, the American Dream is to take a great idea and turn it into a thriving business. Yet it’s rare that a great idea alone will convince an investor or lender to take a chance on you. Before a lender in particular will approve your application for a business loan, you typically need to prove that you and your business are good credit risks. Some borrowers may have trouble satisfying the qualification requirements of traditional commercial lenders—especially startups and small business owners with less-than-perfect credit. This inability to access financing could be a key factor that drove 61% of small business owners to rely on personal funds to address financial challenges in their companies in 2021 (based on a Federal Reserve report). If you find yourself in a similar situation where you need business capital, but traditional financing doesn’t make sense, peer-to-peer (P2P) lending could be worth considering. Here’s what you need to know about how this alternative business loan solution works. You’ll also learn whether P2P loans are safe and how to determine if they are the right fit for your small business. What Is Peer-to-Peer Lending? Peer-to-peer lending is a method of borrowing money that allows you (aka the borrower) to access funds from multiple investors (aka peers), rather than a single lender or financial institution. Due to this unique borrowing structure, P2P lending is sometimes called person-to-person lending or social lending, as well. P2P lending platforms utilize technology to bring different investors together to fund an individual loan. Some P2P platforms may even allow lenders to compete with one another to make loans—sometimes (though not always) resulting in more attractive interest rates and loan terms for borrowers than they might receive elsewhere. In other scenarios, borrowers may be able to qualify for financing that they might not otherwise have qualified to receive. How Does Peer-to-Peer Lending Work? Peer-to-peer lending marketplaces use fintech (aka financial technology) to match would-be investors with would-be borrowers who are seeking various types of loans. It’s important to understand that P2P platforms are not lenders themselves. However, the online platform can help perform the following tasks: Collect and process a loan application from the prospective borrower Facilitate a credit history and credit score check Share your potential loan offer (including APR and fees) if you’re eligible for financingMove your loan to the funding stage, if you accept the offerShare your loan listing with investors to see if any are interested in funding itService funded loans, process monthly payments, and divide payments among investorsContract with third-party debt collectors to collect defaulted debts Is Peer-to-Peer Lending Safe? The U.S. Small Business Administration (SBA) notes that peer-to-peer loans could be a practical alternative financing solution for small businesses. Yet the agency cautions that there are both benefits and drawbacks to consider before a business decides to move forward. As a borrower, one of the first details you should understand about a P2P loan is the cost. In addition to the interest that the investors charge on your business loan, the P2P platform may charge supplemental fees. (Investors may pay fees to the P2P platform, as well.) Of course, any type of financing comes at a cost, but it’s always wise to do the math, so you know what you’re agreeing to pay for a business loan up front. For investors, it’s important to know that P2P investments are not FDIC-insured. Therefore, you may face an added degree of risk with this type of investment compared with other options. At the same time, if the process goes smoothly, you might enjoy higher returns than you’d receive from FDIC-insured CDs or savings accounts. It’s up to you to determine your risk tolerance and how much of your portfolio you’re comfortable exposing to higher-risk investments. Is a Peer-to-Peer Loan Right for You? If you’re wondering whether a peer-to-peer loan could work for your business, there are a few details you’ll want to consider. First, it’s wise to review your credit reports and scores (from all three credit bureaus, if possible). A lender will likely review one of your consumer credit reports and scores when you apply for a P2P loan. Therefore, it’s helpful to know the condition of your credit before you apply for financing. You can access a free credit report from Equifax, TransUnion, and Experian via AnnualCreditReport.com once every 12 months. Through the end of 2023, you can take advantage of free weekly credit report access through the same website. Next, make sure you’re in a position to afford a new business loan. If you believe your company might struggle to afford a new monthly loan payment, now may not be the time to seek new financing. Finally, shop around and compare P2P loan offers from multiple companies. You may also want to consider other types of small business loans. Comparing different financing offers can help you make sure you find the best deal available for your company.