Need small business funds? Avoid the banks

If you have a business idea and you can’t seem to get any funds from a bank, there are more and more alternatives to try. One of the best approaches can be traditional peer-to-peer (P2P) lending sites.

P2P lending is a way to cut the banks out of the equation. It lets people go online to borrow and lend money directly to each other. Prosper.com is the granddaddy in the field, and LendingClub.com has been growing nicely in recent times too.

Here’s how P2P lending works for a potential borrower: You agree to a credit check and to disclose your debt-to-income ratio. Based on that information, you’re assigned what amounts to a credit risk score. Taking that score into account, you’re assigned a letter grade (from AA to E) and an APR befitting the credit risk you pose to potential lenders.

Lenders protect their interests in P2P lending by buying little tiny slices and dices of multiple loans, instead of pouring all their dough into one big loan. That way if any given borrower defaults, a lender only loses a fraction of his or her money, not the whole amount.

In the early days of P2P lending, companies like Prosper and LendingClub didn’t set high enough standards about who could borrow and they didn’t adequately communicate to investors (lenders) about the level of risk involved. So the business model kind of blew up in everybody’s face. Now the standards have gotten more refined and more sophisticated with time.