Marketplace lending, also known as peer-to-peer (P2P) lending, rose to prominence in the chaotic aftermath of the 2008 financial crisis. Today, it remains an option for businesses that can’t qualify for traditional loans and lines of credit, but are marketplace loans a better option than factoring in these cases? 

In this article, we’ll compare marketplace lending to invoice factoring as a way for small and mid-sized businesses in the U.S. to unlock working capital.

What is a marketplace lender?

A marketplace lender provides a technology platform that connects borrowers to investors (individuals or organizations) that are willing to advance them loans. Early on, many of these platforms facilitated loan agreements between ordinary individuals or “peers,” which is why they are sometimes called “peer-to-peer loans.” 

Over the years, this peer-to-peer model has undergone considerable upheaval and change in response to market pressures. Early marketplace lenders had to adjust the strategy as high default rates, regulatory scrutiny, and other market realities placed pressure on their business models. After a wave of bankruptcies and acquisitions, today’s marketplace lending is now focused on supporting dedicated lenders—people or organizations that lend out their capital at scale to generate a competitive return on their investment. 

While marketplace lending has evolved over the years, it continues to offer businesses a way to access capital when traditional banks are not an option. 

The pros and cons of marketplace lending 

Business owners who don’t qualify for traditional loans and lines of credit can often qualify for marketplace loans because the lending criteria are more flexible. However, that flexibility comes at a cost. Before you apply for a marketplace loan, you need to be aware of the pros and cons.

In the “pro” column, marketplace loans impose less restrictive criteria on business applicants. Factors such as the amount of time the company has been in business, the owner’s personal credit score, the business’s profitability, and its debt service and debt-to-income ratios all tend to be evaluated more leniently for a marketplace loan. 

The other, significant “pro” is that the loan can be approved within days of application. Marketplace lending platforms are powered by underwriting algorithms that automate credit decisions and pull relevant data directly from digital sources, so they can bypass time-consuming manual processes and human review that can cause bank loans to take weeks to be approved. 

But that speed and flexibility come at a cost. The higher risks lenders take on are reflected in interest rates that can go as high as a 30% annual percentage rate (APR). Along with setup and servicing fees and penalties for early payments, the cost of borrowing can add up quickly. 

Marketplace loans also tend to come with strict financial covenants that impose continuous monitoring and payment control on the borrower. Lenders can access the borrower’s bank account, monitor transactions, and set up automated ACH payments as well as preventing the borrower from taking on additional debt. For many businesses, especially those with highly variable or seasonal cash flow, this level of control and enforcement can be highly disruptive, leading to insufficient funds for payroll and other business expenses. 

Comparing marketplace lending to invoice factoring

Similar to marketplace lending, invoice factoring is a form of financing that is accessible to businesses that need more access to working capital than a bank will lend them. Invoice factoring, also known as accounts receivable financing, allows businesses to sell their invoices for immediate cash so that they can use the funds as soon as the customer is billed. 

While invoice factoring is more expensive than a traditional bank loan, it is much more affordable than marketplace loans and other types of alternative financing, including online loans and merchant cash advances. Factoring also comes with fewer restrictions and more flexibility, which can be an important consideration for businesses that value their ability to move quickly and operate freely in the market.

The table below compares some of the key characteristics of marketplace lending and invoice factoring. 

	MARKETPLACE LENDING	INVOICE FACTORING
Funding speed	FAST: Funding can be received within days.	FAST: Funding can be received within days.
Customer impact	NO. Customers will not be aware that the business has obtained a marketplace loan.	YES. Customers are informed of the factoring line and receive new remittance instructions.
Funding costs	HIGH. Interest costs are 2-3X higher than traditional loans and can reach 25%, plus setup and servicing fees and penalties.	LOW. No interest is charged on the advanced funds, and fees can be as low as 1% of the invoice amount.
Credit criteria	HIGH. Business needs to demonstrate a specific credit score.	LOW. Business does not need to meet a specific credit threshold. Instead, customer creditworthiness is the criterion.
AR criteria	NO. Business does not need to have steady receivables or proven accounts receivable.	YES. Businesses must have proven accounts receivable in order to receive advanced funds.
Value add	NO. A marketplace loan provides funds only to the business.	YES. A factor provides AP and collection services to the business.
Financial controls	HIGH. Marketplace lenders require control over the business’s bank account, apply covenants that restrict the ways the business can use the funds, and prevent the business from taking out additional loans.	LOW. The factor does not control the business’s bank account and does not apply any covenants that restrict the ways the business can use the funds. The business is free to make any additional financing arrangements at their discretion.

 

The bottom line: Who should choose invoice factoring? 

Businesses with healthy AR and creditworthy customers who want to secure additional working capital without paying high interest rates or signing restrictive covenants should consider invoice factoring. Using existing invoices to unlock working capital rather than taking out a marketplace loan can help your business minimize costs and maximize autonomy. 

However, if your business does not have very much AR on the books, and if your customers don’t tend to maintain good credit scores, a marketplace loan may be your best option. 

If you’re interested in learning more about invoice factoring and finding out how much capital you could free up within days, contact us.