Small business online loan crowdfunding: who gets funded and what determines the rate of interest?

Abstract

The advent of online peer-to-peer crowdfunding presents a new type and source of finance for small firms. This raises the question of whether this innovation makes any difference to the type of business that can secure funding and the amount that they pay for this finance. In this paper, we examine the American online peer-to-peer loan crowdfunding website www.prosper.com to answer these questions. We create and analyse a dataset of 14,537 small firm unsecured loan applications. We find that lenders in this market ignore business characteristics and focus on personal characteristics instead, particularly a person’s credit score but also whether they are employed and provide a picture. This implies that entrepreneurs who want to raise finance in this market will need to use a very different pitch than the norm in the offline market—as personal rather than firm characteristics are the main determinants of securing funding and the price paid for it.

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Notes

  1. 1.

    Where quality stipulates the borrower credit risk such that high-quality borrowers are the low-risk borrowers most likely to pay back the extended funds, while low-quality borrowers are the high-risk borrowers who are less likely to pay back the extended funds.

  2. 2.

    Those likely to pay back the extended funds.

  3. 3.

    The ‘strength’ of an interpersonal tie is a linear combination of the amount of time, the emotional intensity, the intimacy (or mutual confiding), and the reciprocal services which characterise each tie (Granovetter 1973).

  4. 4.

    A borrower is extended credit if his loan request attracts at least 100% of the requested loan size within the duration the listing (loan application) remains active to receive funding—for Prosper, this duration is typically 7 days (Zhang and Liu 2012). For our study period, partial funding was not permitted in this market. If a borrower failed to raise 100% of what they asked for within the duration of the listing, and they would still desire to borrow money, they would have to re-list the loan request on the website, and the bidding process by lenders on the loan application would start anew.

  5. 5.

    Due to missing values for some independent variables, the number of observations is smaller than indicated in Sect. 3.1.

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Kgoroeadira, R., Burke, A. & van Stel, A. Small business online loan crowdfunding: who gets funded and what determines the rate of interest?. Small Bus Econ 52, 67–87 (2019). https://doi.org/10.1007/s11187-017-9986-z

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Keywords

  • Crowdfunding
  • Peer-to-peer lending
  • Small business finance

JEL classification

  • G10
  • G23