Debt crowdfunding for small businesses
Over the past decade, crowdfunding has risen to one of the top funding sources for entrepreneurs looking to launch a business or scale. There are undeniable reasons for it.
Debt-based crowdfunding platforms offer far better loan conditions for business owners or business-owners-to-be: lower interest rates, quicker approval time, and a more straightforward application process.
With debt crowdfunding, there are simply more chances to realise your entrepreneurial ambitions. Imagine you have an idea. It may be great, or it may not. But the truth is, you’ll never know if anything comes out of it if you don’t get the funding.
On the other side of the bargain, debt crowdfunding is also an attractive alternative.
Firstly, investors get their money back in regular monthly instalments with interest, a common way to build passive income. Secondly, it’s an opportunity to help businesses you see important to society.
In this article we will discuss how debt crowdfunding works, why it’s a viable funding option for small businesses, and what one should know before applying for a loan through commercial debt crowdfunding.
What is debt crowdfunding?
Debt crowdfunding implies a number of investors lending their money to businesses or individuals on debt-based crowdfunding platforms or debt-based crowdfunding marketplaces. The borrower then pays back the loan on a monthly basis with a certain interest fee on top of it.
Next to debt-based crowdfunding, there are also other crowdfunding types for entrepreneurs to consider.
For instance, equity crowdfunding provides investors with partial ownership, equity, of the company they invest in. It’s a separate crowdfunding brunch with various platforms to get familiar with.
Another alternative is reward-based crowdfunding. As the name suggests, investors get a “reward” in return for their capital. It may be early exclusive access to the company’s product, such as a computer game, or a regular supply of the product for free.
Regardless of the business model, it’s safe to say that crowdfunding has grown into a worthy alternative to traditional forms of financing for small businesses in startups. Given its dynamic, experts expect the crowdfunding market to mark $300 billion by 2025.
How does debt crowdfunding work?
The entire process is intuitive and may vary depending on your chosen platform. To give you a general understanding, here are the basic steps debt crowdfunding involves:
- A potential borrower registers on a crowdlending platform and applies for a loan by filling in personal details and submitting a proposal. Every platform has its own submission form and may require different information.
- The platform evaluates the proposal if it’s a viable investment option.
- Once approved, the platform will offer the borrower repayment rates, applicable fees, and other loan details.
- Finally, once a borrower agrees, there are two scenarios:
- The borrower’s campaign gets published on the platforms, and the investors can choose the amount they’d like to allocate. Once the campaign’s timing is out, the borrower receives the money collected.
- The borrower receives the funding initially requested and proceeds with monthly instalments to the investors, just like a regular P2P loan.
Debt crowdfunding types
It’s true that the term “debt crowdfunding” is more of a general term often used referring to one of the loan types below. Though the main mechanism behind them doesn’t vary greatly, we believe it’s worth elaborating a bit on the debt crowdfunding definitions you may come across today.
- P2P lending, or peer-to-peer lending, matches individual borrowers or business owners looking to raise capital for personal or business purposes with an investor or a group of investors.
- Micro lending is not much different from P2P lending. In some cases, loans below a certain amount are regarded as micro loans. Such distinction is more common for non-profit and social organisations operating in the US.
- Invoice financing allows businesses to make up for any unpaid invoices by their clients. Invoice financing allows injecting funds against the outstanding bills to keep the cash flow steady and stay with the client on good terms by postponing the invoice due date. After all, we are all human, and delays can happen for numerous reasons.
Debt crowdfunding pros
Debt crowdfunding and small businesses may indeed look like a match made in heaven. Here the considerable advantages:
- A cheap yet solid way to test out your idea.
If the audience doesn’t like it, consider it a blessing in disguise. You haven’t wasted your capital on a business that doesn’t speak to the market’s current needs.
On the other hand, if things go well, you may receive valuable feedback to fine-tune the product. In fact, you may get in touch with experienced investors or people from your industry to get sound business advice and who knows, maybe plan future collaboration.
- Easier funds access.
Let’s acknowledge it: most startups can hardly meet the standard bank requirements. Having the possibility to crowdfund the necessary funding without extra bureaucracy – is a big reason alone to choose debt crowdfunding over traditional financial institutions.
No long formal meetings, just your idea wrapped up into a compelling presentation.
- Free marketing.
If your product idea hits it with the people, it means you are building your target audience, even before the product or service is available. This is something called early adopters or brand advocates. It’s one of the reasons why your campaign needs to be thought through in terms of PR, communication, and design.
From the very beginning, keep in mind that it’s not only a loan request but an advertising campaign that may be a foundation of your future client’s base. This is where your brand engagement and loyalty start.
Debt crowdfunding cons
As you may guess, in this paragraph, we’ll cover all the pitfalls debt crowdfunding encompasses.
Naturally, there are many factors to pay attention to, like the platform fees or the meeting the platform’s criteria for your application to be accepted. All the debt-based crowdfunding platforms assess your creditworthiness in the first place, so it’s essential to have your finances in order.
Still, the most significant risk with debt crowdfunding is your ability to repay the loan. Every business has its ups and downs, that’s why it’s important to work on the financial forecast to have a realistic vision of your payment ability to return the funds borrowed.
If your business fails to repay the debt, you’ll have to sell the assets. If you also provided a personal guarantee when signing the loan, this may also affect your personal assets and have a negative impact on your credit history.
Crowdfunding campaign tips
If you have decided against a crowdfunding campaign to raise money, be sure to figure out the right approach. To help you structure the strategy right, here are some tips for how to boost a crowdfunding campaign:
- Start with a business plan.
Apart from accurate calculations of your business projections, we recommend looking up other crowdfunding cases: successful stories and more importantly, failures. On the one hand, it’ll give a realistic idea of your chances, and on the other hand, it’ll help you to come up with a reasonable financial goal for your campaign.
- Marketing is everything.
If you follow the paragraph above, you’ll notice that all the great crowdfunding campaigns paid a lot of attention to the marketing side of the deal. Make sure that your presentation looks powerful and persuasive.
Think how you can drive interest from outside: social media, events, partnerships, news channels, etc.
- What’s your story?
Don’t make it just about the numbers. Why is this idea so important to you? What’s the story behind the company? How can it change the community or the market?
People care about the products that feel relatable to them. It’s crucial to make an emotional connection with potential investors or even future clients, that’s why you need to stand out.
Despite the risks any loan or investment implies by definition, debt crowdfunding is an efficient way to gain the necessary capital to grow or scale.
Yet, what makes it really special, is the unique community value one can hardly find elsewhere.
Unlike other crowdfunding types mentioned earlier, investors have an opportunity not only to put the money to work but also to contribute to businesses that speak to their values and vision.
Hopefully, this article has helped you better understand debt crowdfunding and whether it’s the right choice for your company’s launch or expansion.
Luckily, there are plenty of debt crowdfunding platforms today, so every entrepreneur can find the one matching their venture specifics and industry.