P2P Lending and Crowdfunding: Viable Alternatives to Traditional Investors?

The first phase of a startup may be fueled by passion, but sooner or later (and most likely sooner), you’ll need to secure funding. Investing your own money, appealing to family and friends, and pitching to angels or venture capitalists are all time-honored approaches, but peer-to-peer lending and crowdfunding platforms are creating new ways for potential investors and startups to connect.

Peer-to-peer (p2p) lending is one option for those looking for a one-time, limited infusion of cash. (At this point in time, loan amounts are typically small, up to around $35,000). By using a platform like Zopa or Prosper, dozens or even hundreds of individual investors can pool smaller loans—sometimes as little as $10—into one loan at rates more favorable than banks can offer. While this approach has worked well for individual borrowers, some companies have preferred to use a more direct route to find investors, either by operating their own platform, partnering with an industry-specific site, or by using a white label platform.

One major restriction facing the p2p industry is geographic restrictions: currently, most p2p lenders can only operate within their country. However, in October 2012, Estonian lender isePankur became the first p2p to offer anyone in the EU a chance to invest in Estonian consumer loans. As p2p lending matures and becomes more familiar to investors and startups, reduced regulation can be expected to lead to a larger pool of investors and larger loan limits.

When loans are unfavorable or unobtainable, though, other startups have turned to crowdfunding platforms. It’s estimated that globally, there are over 300 platforms dedicated to crowdfunding, and that it could grow to be a $3 billion industry in 2013. Some platforms, like Kickstarter, can only offer rewards like t-shirts or discounts to donors, but equity crowdfunding, in which investors contribute as little as 20 euro in exchange for a percentage stake in the startup, is attracting investors’ attention.

Equity crowdfunding in Europe has already shown great promise. UK-based Crowdcube recently helped professional networking site Escape the Cityraise £600,000 from 394 investors in two weeks. What’s particularly notable is that this was not a last-ditch effort to raise capital; the startup had already turned down offers from two established venture capital firms. In the Netherlands, Symbid has also found a willing audience: 372 investors from around the world contributed €100,00 to help Enviu invest in other sustainable businesses.

The United States has been slow to approve equity crowdfunding—although the JOBS Act was passed in April 2012, specific rules have yet to be released—but companies are already preparing for new investors. WeFunder has solicited interest from investors, and existing sites like Kickstarter could easily expand to equity with its existing community.

Of course, peer-to-peer lending and crowdfunding have risks for startups and investors alike. Startups may find it more challenging to attract secondary funding, as crowdfunding investors may not have sufficient funds or venture capital firms seek to avoid dealing with other investors. Investors, meanwhile, may lose money on failed startups and scams.

Perhaps even more important than funding, though, is access to advice.  VC firms are accustomed to guiding founders through the building process and open doors, which individual investors may not be accustomed to. In the long-term, this may prove to be another strength, as startup founders can turn to a wider pool for input and connections. The transition to p2p lending and crowdfunding may be challenging, but the potential for both startups and investors cannot be ignored.