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Business loans, minus the bank

Is Chicago startup LendSquare the next Kickstarter?

November 29, 2012|By Georgia Garvey @gcgarvey | RedEye

There's a well-worn cliche in business that it takes money to make money.

But what if you're like Steven Lucy, the 27-year-old co-owner of Open Produce grocery store in Hyde Park, and you have the business but not the capital? What if your produce lies, wilting in a hot summer store, while you struggle to get the cash for an air conditioner?

"Banks are an inefficient way of allocating money," said Lucy, who found himself in just such a position earlier this year. "There are entrepreneurs out there that could do things but they don't have a house to put up as collateral and they don't have rich friends or family."

Lucy wound up turning to LendSquare, a Chicago startup with a unique approach. The website lets people loan money to businesses in their community. No bank required.

"There is this huge, huge gap in the availability of credit, which is tragic, because there are many things that businesses need to do," said Sebastian Villarreal, founder of LendSquare. "If I didn't do it, the need for it is so huge that someone else would have."

The idea of lending money to, and making a profit from, businesses you already support financially makes sense to Laura Pincus Hartman, professor of business ethics at DePaul University.

Then, she said, lenders "have skin in the game." They know the business, perhaps already patronize it, and have a vested interest in making sure it succeeds. If you lend money to the local burger joint, you might bring friends there when you're looking for a restaurant to go to on your night out.

"It's nice from the community-building perspective in an environment [like lending] where you don't usually have those relationships," Hartman said.

The LendSquare loan process has a few stages. First, businesses determine how much money they want to borrow, based on what they can afford to repay each month. They pick an upper limit of interest they'll pay—say 12 percent, for example. People then "bid" on the amounts they want to loan to the business, saying how much interest they'll charge.

Bidding on the loans is set for a period of time and once that time's up, if not enough people have bid on the loan, it won't go through. If more people have bid on the loan than are necessary to meet the loan amount, those offering the lowest interest rates are allowed to lend the cash. Lenders get repaid at the highest interest amount bid.

"It was much easier than [getting a loan from] a bank, to be honest," Lucy said. Open Produce took out a $7,000 loan for an air conditioner, wound up getting the loan for 4 percent interest, and is repaying the money in a two-year plan with monthly payments of about $300. "When you go into a bank and apply for a loan, which I've done many times and I've always been turned down, they don't really care about your business."

Lucy said he also liked that the business wasn't asking for charity, like with a Kickstarter fundraising campaign. They would repay the money, with interest, to its lenders.

"It wasn't like, 'Give us money.' It was like, 'Lend us money,'" he said.

Another business owner who turned to LendSquare was Doug Brandt of Lakeview restaurant Pie Hole, who sought to borrow $30,000 to open a second location.

With the funding model set up by LendSquare, Brandt said, "there's a lot incentive to be a part of your community. I hope this will be a way to entice people to get involved."

It's not all free money and love, though, with LendSquare. It's not a charity operation. LendSquare makes its money by taking a 2.5 percent fee of the total loan amount from the borrower. They also take a monthly fee from the borrower that's half the percentage amount they were saved from their initial bid. For example, if a business says they'd pay 12 percent interest and the lenders wind up requesting only 10 percent, LendSquare would take 1 percent a month from the borrower.

There is also nothing to prevent a business from defaulting on its LendSquare loan and failing to repay it. Villarreal said LendSquare does ask for cash flow documents to see how much the businesses have coming in. If they are trying to take on a loan outside of their ability to repay, he said LendSquare will exclude them.

"The truth is that small business loans are always risky," he said, noting that most people wouldn't loan money to a business they see is struggling or mismanaged. "I'm not going to lend money to a business that's always empty. There's kind of a built-in filter."

For now, LendSquare remains in the early phases of development. It has facilitated seven business loans so far and just did its first loans in June. But Villarreal remains optimistic.

"I think what we're doing is really cool," he said, "and the response that we've gotten is so encouraging.

"The idea that people would lend money without too much financial information ... no one knew if it would work."

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