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Borrowing from Strangers

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The Internet has made it easy for people to go online to find everything from a date to a used car. Social networking has taken things one step further with people creating communities around shared interests.

Now the web is making it easier to borrow money from a community of strangers using a concept called "peer-to-peer lending." It's not a new concept for entrepreneurs to reach out to "friends and family" for early stage funding. This is one of the most popular ways of getting capital for many small and emerging businesses. But now, entrepreneurs are using the web to find virtual "friends & family" -- strangers willing to give them a loan. At a time when access to capital is still very tight, this is an interesting option.

I recently interviewed a former Wall Street trader turned restaurant entrepreneur who has gotten over 100 strangers to invest in his business without ever meeting them.

David Morris and his brother Dan were both Wall Street guys but their dream was to open a neighborhood restaurant on Long Island. Nothing fancy -- hot dogs and burgers. They had a name -- JimmyJacks and a dream. David left his job on Wall Street in 2009 to spearhead the plans. They were ready to put their money where their mouth was (literally!) and get started. They invested $90k of their own money, but they needed an extra $20-25k for contingencies. They were well-connected on Wall Street and had good credit, but over 20 banks turned them down. Even the SBA could not help. "We were a little let down. We were surprised that we couldn't get the money," David said. Some banks said the amount they were looking for was almost too small. They were told that if they needed $250k it may have even been easier to get a loan or go to an angel investor group.

So, they turned to strangers, using a relatively new concept called "peer-to-peer lending". There are several companies now offering this. One of the largest is Lending Club, started in 2007. Most peer-to-peer lenders, including the Lending Club, match individual lenders with individuals seeking loans for everything from weddings, credit card repayments and auto loans to small business loans. For entrepreneurs looking for relatively small amounts of capital -- usually $25k or less, this can be a good, fast way to access money.

The application is fairly simple -- almost as easy as a credit card application. You need good credit, some income and you need a compelling story. Investors can choose to invest based on a number of criteria including interest rate, amount of the loan and what the loan will be used for. For many, they are looking at this just as an investment but for many it's also a way to do something good with their money and help out a stranger. This is where the social networking comes in. People want to feel connected to the loan recipients and sometimes to other lenders in the online community. So, a compelling story can help.

Almost immediately as soon as the Morris' loan was posted, people started emailing them and asking questions directly. They watched their loan total growing in real time. According to Lending Club, most loans are funded within two weeks.

Sure enough, within two weeks, 100 lenders -- all strangers -- had lent them $20,000 (an average of $200 per microloan); Terms were better than they could have gotten from most banks- 3 yrs at around 13%.

The Morris brothers are not alone. On Lendingclub.com, I found a $10k loan request that had been posted for a little over a week and was 96% funded. Another, for $25k was also posted 10 days ago and was already 30% funded. Lending Club has funded over $86m in loans since they started in 2006 -- that's over 9,000 loans. That number has more than tripled in the last year.

And other peer-to-peer lenders like Prosper are also growing although Pertuity Direct, a competitor closed down in 2009. Kiva.org has gotten a lot of buzz and focuses on international micro-finance loans to small businesses mostly in emerging markets. They are a non-profit though, so investors get their money back but without interest.

Peer -- to-peer lending is not without some controversy -- it's a fairly new concept that the SEC seems to be taking a much closer look at. Lending Club is registered with the SEC and issue prospectuses for all loans. But, as with anything where money and strangers are involved, investors and entrepreneurs should do their homework and make sure that you are working with a reputable group.

Listen to my interview with the David Morris on WOR Radio