We are lucky today to have a great guest post by Tabitha Creighton, the CEO and Co-founder of InvestNextDoor. Thank you Tabitha!
Show me the money! (please)
Until recently investing in a small business has been inaccessible for the average investor. Generally the only exposure a retail investor had to small business lending was when you were asked to loan money to your friend, neighbor or relative for their business.
So where have small businesses been getting money all these years? Surprisingly, only 20% of the time they get their money from banks. The remainder of the time they use their own personal credit sources, high interest alternative lenders, or just do without. 
Even private equity firms and hedge funds have had limited exposure to small business credit markets except through secondary markets buying wholesale portfolios of loans or securitized lending products.
But why? That’s simple. To lend to a business “officially”, you either had to be a bank or a commercial lender. So if you weren’t either of those you could only lend to a business by buying the loans from the primary lenders.
Enter peer-to-business lending (or Crowdlending).
Peer-to-business (or Crowdlending) describes the function of retail investors being able to function as the primary lender to small businesses directly (typically through a “portal intermediary”). For clarity, a “retail investor” is any person making an investment, rather than an institution or commercial lender.
This is different than the intermediated peer lending like Prosper or Lending Club, where borrowers are actually getting a loan from a bank, who then sells the loan to Prosper or Lending Club; and then they in turn, sell the retail investor an unsecured note to pay a return, based on the payments they receive from the borrower. The visual below describes the difference:
Both forms of lending allow retail investors to participate. The advantage of direct peer-to-business lending is that the retail investor gets all of the structural advantages of being a direct creditor (can hold a UCC filing, is a creditor in case of bankruptcy, collateral is possible), and all of the service benefits of intermediated peer lending (full servicing, dashboards, portfolios).
How risky is it?
Like with any investment there are substantial risks. Default rates are typically in the neighborhood of 2% with a well-diversified portfolio (making many small investments, instead of one large one). Most platforms use proprietary underwriting criteria similar to what the banks use to rate the risk and provide interest rates.
What does the retail investment opportunity look like?
Retail investors have the opportunity to participate in peer-to-business lending which has average returns of 5-12%, typically with monthly repayment over 1 to 3 years. So, as Ron Suber, CEO of Prosper recently said at the 2014 Crowdfunding Symposium at UC Berkeley, retail investors will be given as much access to peer-lending markets as they want – but institutions will pick up any slack in retail demand. And they are, and they’re making a tidy profit with returns in the low double digits – net of defaults and delinquencies. Which is an impressive return for any fixed income investment – any investment, really. In fact, for those who have fixed income investments earning double digit returns out of the peer-to-peer space, I’d love to hear where they’re coming from so we can all get in on the action.
Along with solid returns, you make a larger impact
So here is the most interesting thing, the social impact of investing in small businesses. Small businesses are the engine of the economy. They provide more than 50% of jobs and GDP. Providing them with capital to expand leads to more jobs, and the returns they give to their investors create more disposable income for consumers. With a single investment we’ve increased Consumer Spending, reduced Unemployment and increased GDP. All while making double digit returns for ourselves.
What are you waiting for? Oh right where can you find these handy-dandy investments?
If you were in the UK or Europe, or even China, you could find them on any number of marketplace lending sites. In the U.S., peer-to-peer investing is much more dominant, having grown to be more than $1B per quarter now. Peer-to-business lending is only available on a select few sites right now, and institutions are buying more right now than retail investors. Places to look for investments include InvestNextDoor, DealRaise, Raiseworks and P2B Investor. Currently, Lending Club does not offer peer-to-business investments in its marketplace, and neither does Prosper.
So what’s the bottom line?
- Peer-to-Business Lending is now accessible to retail investors
- Banks and institutions are capitalizing on these types of investments
- There opportunity for 10+% returns and a regular monthly cash flow
- You become a small business game changer AND help the local economy
Author: Tabitha Creighton is CEO and Co-founder of InvestNextDoor
 Biz2Credit and Kaufmann Foundation studies