You’re a small business. You’re doing well. But even though you’re turning a profit, the bank just won’t give you the loan you need to expand. So what do you do? Well, there are a number of viable alternative finance routes you can go down with the two main avenues being: Debt crowdfunding or Equity crowdfunding. Both are similar business models, but with different long-term consequences for cash flow and profitability. Which is best for you depends on the type of business you have and how long it’s been running for.
Debt crowdfunding, also called peer-to-peer (P2P) lending or crowdlending, allows businesses to borrow money from an online platform funded by many different investors. These platforms use the Internet to reach thousands – if not millions – of potential fundraisers, so it’s never just one or two people funding the loan. Each investor submits the amount they want to invest and the interest rate they would like to receive. Once the loan is filled, the final rate of return is calculated using an average of all the bids submitted. Providing you’re happy with the result, the loan goes ahead and then you begin to pay back your investors in regular monthly instalments with interest.
There are no banks involved. The benefits to you as a borrower are that loans can be agreed faster and the interest rates are generally lower. This is due to the fact that these crowdfunding platforms are all based online. The money they save from not having buildings, general administration costs and the like is passed on to you through the lower interest rates.
Debt crowdfunding is great when the money is raised for a single purpose over a select period of time, such as opening a second shop. If your business has been around for a couple of years, and you have assets and enough cash flow to make the repayments, then debt crowdfunding could be for you.
Just like debt crowdfunding, different people come together to invest in your business. But this time they’re doing it in return for equity, a small stake in the company. Investors make their money once your company is sold or floated on the stock market. If it fails, you risk losing everything invested in the company.
Equity crowdfunding is a great way for a new company to gain a lump sum of money in order to establish itself. However, the downside is that you’ll have to give up a certain amount of ownership. As the level of risk is a lot higher, investors may want information, and perhaps even a have more active presence in the day to day running of the company such as, how the money is spent.
The Pros and Cons for Investors
Small businesses don’t really have much to lose from alternative finance; investors, on the other hand, need to exhibit more caution. A high return on your investment can come at a price, especially when talking about equity crowdfunding. If you invest in an unestablished business or start-up, in return for shares, there’s always the possibility the company will fail meaning you could lose everything. Debt crowdfunding, on the other hand, is less risky. Many peer-to-peer lending platforms have procedures in place to recoup losses should a business be unable to repay its debt. Plus, there are things you can do to minimise the risk to your investment. Simply diversify your portfolio by investing small amounts in many different companies, that way if one company defaults on the loan the effect on your return will be minimal. Also, peer-to-peer lending companies like LendingCrowd have robust credit processes which analyse the historic accounts of the business looking for a loan. This helps us to make informed decisions on whether a loan application is accepted or not. Here’s more on how we evaluate a loan application.
Which is best for my Business?
So, now you know the difference between equity and debt crowdfunding, have a look at our quick summary to see which is the best option for you:
Debt Crowdfunding or Peer-to-Peer Lending:
- Borrow money from an online platform funded by investors
- Loan is paid back, plus interest, over a fixed term (normally 3-5 years)
- Interest rates are generally lower than from a bank
- Only businesses with good credit ratings are accepted as applicants
- Investors have no say over how the loan is spent
- Investment is given in return for shares, or stake in the business
- Ownership may be partly given up in return for investment
- Popular method for start-ups
- High level of risk for investors
In summary, if you have a great idea for a company, project or venture, that’s yet to get off the ground, then go for equity crowdfunding. But, if your business is established and you’re looking for a loan, then peer-to-peer lending is better for you.
Remember, in order to be accepted onto a peer-to-peer lending platform, like LendingCrowd, you have to go through strict credit checks, as well as provide solid business plans and the reason why you need a loan.
Or, if you feel equity crowdfunding might be right for your business, then there are quite a few legal requirements that you’ll need to deal with. Plus, you’ll also need to make sure you keep your shareholders in the loop with what’s happening further down the line.
Both ways of alternative finance are great for small businesses who can’t get a loan through the bank. Whichever route you choose, make sure you thoroughly look into the pros and cons of each method before deciding.