Crowdfunding has risen in prominence over the past decade to become major source of business financing for companies and entrepreneurs all over the world. However, while services such as Kickstarter and Patreon garner the lion's share of attention, there's another kind of crowdfunding available Body that applies crowdfunding principles to traditional forms of lending. This hybrid method of raising capital is becoming referred to as debt crowdfunding.
Perhaps you're already considering debt crowdfunding being an choice for your business, startup, or creative project, or you're simply curious about the idea. In either case, it's important to know very well what debt crowdfunding is, how it differs from other forms of crowdfunding, and just how technology-not only to boost funds for the business.
What Is Debt Crowdfunding?
Debt crowdfunding is sometimes referred to as “peer-to-peer (P2P) lending” and “crowdlending,” because it combines the concepts of crowdfunding and lending. A crowdfunded loan works much like a traditional business loan from a bank or any other lending institution in that cash is sent to the borrower with a lender. As a swap, the borrower repays the loan with interest on the specified period.
However, there are some key differences between traditional loans and crowdfunded loans. With the latter, your borrowed money is disbursed by a debt crowdfunding platform, not really a bank or other lender. And while the crowdfunding platform supplies you with the funds, the cash comes from individual investors who pledge to supply a part of your loan funds. When you repay the crowdfunding site with interest, the funds are then distributed to the person investors.
Considering how difficult it has become to be eligible for a a bank loan since the financial collapse of 2008, it's little wonder that businesses have been turning to debt crowdfunding in greater numbers. Debt crowdfunding allows you to market your funding campaign to individual investors rather than counting on anticipation that the large, opaque institution finds your company worthy of support.
How Debt Crowdfunding Works
With debt crowdfunding, potential borrowers submit a loan proposal to some crowdlending website. The woking platform assesses your proposal to judge its suitability. If your application qualifies, the platform then provides you with rates and costs that correlate with the degree of risk the loan poses to potential investors. The riskier the investment, the greater money the peer lenders will want in return, leading to higher rates of interest for your loan.
As we explain within our piece on P2P lenders, the main advantages of P2P loans over traditional business loans provided by a bank or credit union are thus:
- Application Process Is Simpler & More Convenient: Unlike a bank loan, which typically involves a lengthy application process and could require such things as business visits, debt crowdfunders let you apply online, usually without requiring a phone conversation.
- Quicker Approval & Funding: Ordinary small business term loans take much longer to obtain funded compared to average P2P loan, making debt crowdfunding a good funding choice for businesses needing funding relatively quickly.
While operating on the same basics, debt crowdfunding sites vary greatly in terms of the types of businesses that they cater. For instance, Funding Circle lends to small businesses with at least 2 yrs of economic history, while StreetShares requires less time in business and it has a specific focus on veteran-owned business. Meanwhile, Kiva US is devoted to startups with no business history whatsoever while offering loans with no interest whatsoever, however it includes a lengthy application process along with a long wait to obtain funded (1 to 3 months). Point being, no two P2P lenders are the same, so your research before applying for any crowdfunded loan.
Check out our explainer article on debt crowdfunding to have an in-depth analysis.
Debt VS Equity Crowdfunding
Equity crowdfunding bears considerable resemblance to debt crowdfunding. Both kinds of fundraising involve the solicitation of investments within the security of your business. The difference is that a P2P loan is simply that – financing. You pay the lending company back on a fixed schedule with interest, and that's that.
With equity crowdfunding, the investor receives an ownership stake inside your business. This sort of fundraising was just recently legalized when the JOBS Act was signed into law in 2012 (the provisions took serious amounts of go into effect). It legalized the advertising and solicitation of securities, thereby allowing businesses to launch equity crowdfunding campaigns.
Investors seeking hot equity investments often search for early-stage ventures with exponential growth possibility to get in around the next big thing. Debt investors, on the other hand, simply be prepared to get paid back plus interest. Because of this, debt crowdfunding is a practicable option for a larger proportion of smaller businesses available than equity crowdfunding. To lots of small business owners, this is probably just as well, considering debt crowdfunding doesn't require you to relinquish any control over your business and forfeit a portion of all your future profits.
Debt VS Rewards Crowdfunding
Rewards crowdfunding à la Kickstarter, Indiegogo, and Patreon is really a beast of the different nature. Legally, rewards crowdfunding isn't investing, therefore it is not regulated as a result, which makes it a less complicated and more straightforward prospect overall.
With rewards crowdfunding, you invite backers to contribute financially to your venture, as well as in exchange, you are offering them rewards. A reward could be a prototype of the new consumer product you're manufacturing, tickets to some viewing of your film, use of exclusive instances of your podcast, etc. It's a method of getting your possible client base excited about adding to your success.
Since it does not entail you taking on debt, rewards crowdfunding looks very good as an alternative to a loan. However, keep in mind that with rewards crowdfunding, what you can do to boost funds relies upon your ability to create your funding campaign go viral. It's a very competitive arena, and perhaps, you will be competing for attention with campaigns backed by crowdfunding agencies. In addition, funding is anything but rapid – your typical rewards crowdfunding campaign is open for 30-60 days. (Patreon-style ongoing campaigns are different, as you're essentially selling subscriptions.) And with Kickstarter, particularly, if you do not meet your funding goal within the time period you initially set, you do not get any from the funds pledged for you – it's all or free.
For the right kind of business venture, rewards crowdfunding can work swimmingly and keep you out of debt. Just know that it's not well-suited to many types of small businesses, requires thoughtful promotion, and is not quick.
When Debt Crowdfunding May be the Right Choice For Your Business
Making debt crowdfunding work for your small business mandates that you have a) a defined need for money, b) a strategy for what to do with it, and c) a plan to pay it back. When compared with other kinds of crowdfunding, debt crowdfunding is both likelier to succeed and (generally) a swifter method of funding. Furthermore, you'll probably have more flexible terms along with a lower interest rate on a P2P loan than you'd having a bank loan (along with an easier application and a quicker time for you to funding).
If there is a great working relationship with your bank, you may consider trying to get a loan from their store instead. And if you're involved in an exciting project or cause with lots of possibility of viral success, among the sexier forms of crowdfunding might ultimately prove more lucrative for the business. However, that also leaves a large swath of small businesses that stand to benefit from debt crowdfunding.
Not The Right Fit? Your very best Alternatives
Let's take a look at some other funding alternatives and see the way they compare well with P2P loans.
Personal Loans
Don't have sufficient business history to be eligible for a a crowdfunded business loan? Consider a personal bank loan instead.
With a good credit score, you might be entitled to a lesser rate of interest having a personal loan than with a business loan. However, borrowing amounts tend to be smaller, too. Still, if you want fast financing for business expenses, personal loans are certainly a choice you should think about.
If you like this idea, check out our piece, How To Get A Personal bank loan For Your Business.
Business Credit Cards
If you have a good credit score, a business charge card has become the simplest way to secure business funding. Business charge cards provide you with use of a revolving line of credit to make use of on business expenses.
Just associated with pension transfer P2P lenders, business creditors report your instalments to the credit bureaus, thus building your company credit. This may boost the odds that you will be eligible for a loans in the future.
In terms of convenience, there aren't many easier funding options than business charge cards. And in contrast to P2P loans, using a business credit card can enable you to get rewards or cash back. Just keep in mind that you may pay a higher APR having a business credit card compared to a P2P loan.
Interested? Take a look at The Best Business Credit Cards for that rundown in your best options.
Merchant Cash Advances
Let's say your a bad credit score score and/or insufficient business history cause you to not able to qualify for either a loan or perhaps a business charge card. You might still be capable of getting a merchant cash advance, which is a sales agreement that will have you selling your future revenue at a discount to a merchant cash advance company.
A merchant cash loan should not be an option of first resort, as the fees are very high, and the repayment periods are very short. An MCA can certainly send you into a debt spiral if you aren't prepared to handle it. However, in case your clients are capable of generating the revenue necessary to repay it, an MCA might be just the thing to keep your business going.
Read our piece on merchant cash advances to learn more.
Final Ideas on Debt Crowdfunding
Debt crowdfunding has become increasingly prevalent in a world where loans from banks are harder than ever before to come by. If you feel a P2P loan is sensible for the business, do your due diligence and compare your available options.
If you have ever removed a crowdfunded loan, drop us a comment and tell us about your experience!
