What Is Debt Crowdfunding & When Is It The Right Choice For My Small Business?

Crowdfunding has risen in prominence over the past decade to become a major source of business financing for companies and entrepreneurs around the world. However, while services such as Kickstarter and Patreon garner the lion’s share of attention, there’s another type of crowdfunding available — one that applies crowdfunding principles to traditional forms of lending. This hybrid method of raising capital is becoming known as debt crowdfunding.

Perhaps you’re already considering debt crowdfunding as an option for your business, startup, or creative project, or you’re simply curious about the concept. Either way, it’s important to understand what debt crowdfunding is, how it differs from other forms of crowdfunding, and how you can use it to raise funds for your business.

What Is Debt Crowdfunding?

Debt crowdfunding is sometimes referred to as “peer-to-peer (P2P) lending” and “crowdlending,” as it combines the concepts of crowdfunding and lending. A crowdfunded loan works similarly to a traditional business loan from a bank or other lending institution in that money is sent to the borrower by a lending institution. In exchange, the borrower repays the loan with interest over a specified period.

However, there are some key differences between traditional loans and crowdfunded loans. With the latter, your borrowed funds are disbursed by a debt crowdfunding platform, not a bank or other financial institution. And while the crowdfunding platform sends you the funds, the money comes from individual investors who pledge to provide a portion of your loan funds. When you repay the crowdfunding site with interest, the funds are then distributed back to the individual investors.

Considering how difficult it has become to qualify for 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 relying on the hope that a large, opaque institution finds your business worthy of support.

How Debt Crowdfunding Works

With debt crowdfunding, potential borrowers submit a loan proposal to a crowdlending website. The platform assesses your proposal to judge its suitability. If your application is approved, the platform then offers you rates and fees that correlate with the degree of risk your loan poses to potential investors. The riskier the investment, the more money the peer lenders will want in return, leading to higher interest rates for your loan.

As we explain in our piece on P2P lenders, the primary 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 may require such things as business visits, debt crowdfunders let you apply online, usually without requiring even a phone conversation.
• Quicker Approval & Funding: Ordinary small business term loans take much longer to get funded than the average P2P loan, making debt crowdfunding a good funding option for businesses needing funding relatively quickly.

While operating on the same basic principles, debt crowdfunding sites vary greatly in terms of the types of businesses to which they cater. For instance, Funding Circle lends to small businesses with at least two years of business history, while StreetShares requires less time in business and has a particular focus on veteran-owned business. Meanwhile, Kiva US is devoted to startups with no business history at all and offers loans with no interest whatsoever, but it has a lengthy application process and a long wait to get funded (one to three months). Point being, no two P2P lenders are the same, so do your due diligence before applying for a crowdfunded loan.

Check out our explainer article on debt crowdfunding for an in-depth analysis.

Debt VS Equity Crowdfunding

Equity crowdfunding bears considerable resemblance to debt crowdfunding. Both types of fundraising involve the solicitation of investments in the security of your business. The difference is that a P2P loan is just that — a loan. You pay the lender back on a fixed schedule with interest, and that’s that.

With equity crowdfunding, the investor receives an ownership stake in your business. This sort of fundraising was only recently legalized when the JOBS Act was signed into law in 2012 (the provisions took some time to 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 look for early-stage ventures with exponential growth potential to get in on the next big thing. Debt investors, on the other hand, simply expect to be paid back plus interest. For this reason, debt crowdfunding is a viable option for a greater proportion of small businesses out there than equity crowdfunding. To plenty 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 a beast of a different nature. Legally, rewards crowdfunding isn’t investing, so it’s not regulated as such, making it a less complicated and more straightforward prospect overall.

With rewards crowdfunding, you invite backers to contribute financially to your venture, and in exchange, you offer them rewards. A reward could be a prototype of a new consumer product you’re manufacturing, tickets to a viewing of your film, access to exclusive episodes of your podcast, etc. It’s a way to get your potential customer base excited about contributing to your success.

Since it doesn’t entail you taking on debt, rewards crowdfunding looks pretty good as an alternative to a loan. However, keep in mind that with rewards crowdfunding, your ability to raise funds is dependent on your ability to make your funding campaign go viral. It’s a very competitive arena, and in some cases, you’ll be competing for attention with campaigns backed by crowdfunding agencies. What’s more, 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, in particular, if you don’t meet your funding goal within the time frame you initially set, you don’t get any of the funds pledged to you — it’s all or nothing.

For the right kind of business venture, rewards crowdfunding can work swimmingly while keeping you out of debt. Just know that it isn’t well-suited to many types of small businesses, requires thoughtful promotion, and is not quick.

When Debt Crowdfunding Is The Right Choice For Your Business

Making debt crowdfunding work for your small business requires 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. Compared to other forms of crowdfunding, debt crowdfunding is both likelier to succeed and (generally) a swifter method of funding. Furthermore, you’ll probably get more flexible terms and a lower interest rate on a P2P loan than you would with a bank loan (along with an easier application process and a quicker time to funding).

If you’ve got a great working relationship with your bank, you might consider trying to get a loan from them instead. And if you’re involved in an exciting project or cause with lots of potential for viral success, one of the sexier forms of crowdfunding might ultimately prove more lucrative for your business. However, that still leaves a wide swath of small businesses that stand to benefit from debt crowdfunding.

For more information on debt crowdfunding and how it compares to rewards- and equity-based crowdfunding, check out our article on the different types of business crowdfunding.

Not The Right Fit? Your Best Alternatives

Let’s look at some other funding alternatives and see how they measure up with P2P loans.

Personal Loans

Don’t have enough business history to qualify for a crowdfunded business loan? Consider a personal loan instead.

With good credit, you may be eligible for a lower interest rate with a personal loan than with a business loan. However, borrowing amounts tend to be smaller, too. Still, if you need fast financing for business expenses, personal loans are definitely an option you should consider.

If you like this idea, check out our piece, How To Get A Personal Loan For Your Business.

Business Credit Cards

If you have a good credit score, a business credit card is probably the easiest way to secure business funding. Business credit cards give you access to a revolving line of credit to use on business expenses.

Just as with most P2P lenders, business credit card issuers report your payments to the credit bureaus, thus building your business credit. This may increase the odds that you’ll qualify for business loans in the future.

In terms of convenience, there are few easier funding options than business credit cards. And unlike P2P loans, using a business credit card can earn you rewards or cash back. Just keep in mind that you might pay a higher APR with a business credit card than with a P2P loan.

Interested? Check out The Best Business Credit Cards for the rundown on your best options.

Merchant Cash Advances

Let’s say your poor credit score and/or lack of business history make you unable to qualify for either a loan or a business credit card. You may still be able to get 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 advance should not be an option of first resort, as the fees are very high, and the repayment periods are quite short. An MCA can easily send you into a debt spiral if you’re not prepared to handle it. However, if your business is capable of generating the revenue necessary to pay it back, an MCA might be just the thing to keep your business going.

Read our piece on merchant cash advances for more information.

Final Thoughts On Debt Crowdfunding

Debt crowdfunding has become increasingly prevalent in a world where bank loans are harder than ever to come by. If you think a P2P loan makes sense for your business, do your due diligence and compare your available options.

If you’ve ever taken out a crowdfunded loan, drop us a comment and let us know about your experience!