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The amount of money you need to start a business can seem intimidating. Even though you may have a great idea, nothing will ever come of it, if you don’t have the funding to capitalize on that idea. This is one reason why crowdfunding has really taken off in recent years. It enables businesses to access the money they need without working through the hurdles of a traditional lender.Loan crowdfunding (also known as debt crowdfunding or peer-to-peer lending) is another alternative source of capital for small businesses. Loan crowdfunding is when a number of investors (a.k.a. the “crowd”) lend money to early-stage businesses or individuals through a regulated platform. In some cases, crowdfunded loans can be easier to get and offer better terms, as well as lower interest rates, than traditional bank loans. Read on to learn more about how debt crowdfunding works, plus how it compares to other startup funding options for small businesses.What is Loan Crowdfunding?
Loan, or debt-based, crowdfunding is a crowdfunding model used to raise capital bytaking loans from several investors (lenders) who expect to be repaid for their loan with added interest over the period that the loan was used. The entire process takes place through a crowdfunding platform.In removing many of the middlemen that would be involved if the transaction happened through a bank, debt crowdfunding can keep the costs down for borrowers while potentially giving the lenders improved rates of return.Loan crowdfunding differs from other forms of crowdfunding. Equity crowdfunding, for example, gives investors partial ownership of a company if they invest in the equity crowdfunding campaign. With reward crowdfunding, on the other hand, a business provides investors with a reward, such as early access to the new product, but doesn’t offer any repayment in the future.What Are the Different Types of Loan Crowdfunding?
There are three main types of loan crowdfunding:P2P Lending Also known as peer-to-peer lending, this is when potential investors are matched with borrowers in search of raising capital. Depending on the loan amount, a borrower may receive funds from a single investor or a group of investors. While borrowers are able to gain access to needed capital without having to meet a lender’s credit requirements, credit scores may be taken into account when calculating interest. Micro Lending Much like P2P lending, micro loans involve individuals issuing loans directly to borrowers. The difference is that these loans are often utilized to support non-profit organizations or underserved communities, but in the U.S. and in developing countries. Another difference is that the amounts tend to be smaller. According to the U.S. Small Business Association (SBA), a microloan is anything under $50,000. However, many micro loan platforms like Kiva typically provide much smaller loans. Invoice Financing This allows a business to borrow against unpaid invoices owed by clients. It’s essentially a line of credit that makes up for any hiccups in cash flow because of delinquent payments. Instead of harassing customers for money, a company that takes advantage of invoice financing can remain on good terms with all of its clients. However, the investors keep a percentage of the invoice once it’s paid. How Do You Find Investors?
The best place to start is online. To raise the money you need to start a business or grow an existing business using this lending model, you’ll first need to register on a crowdfunding or peer-to-peer lending platform. Some debt-based crowdfunding platforms you may want to check out include:Once you register with a platform, you will likely need to draft a pitch with the details of the loan your are looking for, such as how much you are looking to raise, the type of investors you’re looking for, how many investors you’re looking for, what your business plan is, and how you think you will accomplish it, and what the funds will be used for.Typically, the platform will then conduct a background check of your company and its principals to prove your credibility. If your offering is accepted, the platform will offer you a rate of return and applicable fees that correlate with the type of business you have and overall risk involved in the business being successful.
You may also need to provide some form of security, such as personal guarantee or a business asset.Once this is complete, the platform can then promote your venture to investors through its online channels.What Are the Benefits of Loan Crowdfunding?
Debt crowdfunding often comes with better terms than traditional loans. For many borrowers, the loans are greenlit faster than they would with a bank or online lender. Standard SBA loans can take a few months to process, but loan crowdfunding can often take place in just a matter of days. The interest rates are often lower, too.As with other forms of crowdfunding for small businesses, the process of applying for debt crowdfunding gets your name out there, can help to create some buzz around your business, and builds a community that supports your business. Unlike other crowdfunding models, however, you don't have to share equity of your company with the investors. This means that they have less of a say in how you run your day-to-day business. As long as you repay the interest on time and there is no fear that the principal of the loan runs any risk, you are generally able to run your business as you see fit. Loan Crowdfunding vs Traditional Small Business Loans
It can be easier to qualify for loan crowdfunding than it is for traditional small business loans. For example, many traditional lenders want to see a strong credit score, financial statements, and tax returns that illustrate multiple years of positive cash flow. To get an SBA loan through a bank can take anywhere from 30 to 90 days. A P2P loan, on the other hand, often only takes a few days. While crowdfunding loans also have requirements, those requirements differ with each platform. If one is too stringent, borrowers can simply try another knowing that the application process will be different with each company. Bank requirements, on the other hand, tend to be the same no matter what institution you’re working with. Similar to a loan from a bank, your debt interest paid to investors can likely be deducted as a business expense under your company’s tax return.What Risks Are Involved With Loan Crowdfunding?
Like any loan, you have to repay the crowdfunded loan, with the agreed-upon fixed interest and within the agreed-upon time -- regardless of how your business is performing.If your business can’t repay the debts, you may be forced to sell off your assets and close your business. If you provided a personal guarantee for the loan, you might also be held accountable for all or some of the debts that your business has amassed. Your assets could be in jeopardy and your personal credit score could drop.
What Are Some Alternatives to Crowdfunding Loans?
Many peer-to-peer lending platforms have maximum loan amounts around only $40,000, so debt crowdfunding loans may not be high enough to meet the demands of many small business owners’ needs. In addition, loan crowdfunding may not be ideal for startups, since investors often prefer investing in businesses that already has a good track record.Fortunately, crowdfunding loans are just one of the many types of financing options small businesses have these days. Other options include:SBA loans The U.S. Small Business Administration (SBA) partners with lenders such as banks and micro-lending institutions to provide loans to startups and small businesses. Instead of directly lending to the businesses, the SBA guarantees a portion of the loan, which lets startup businesses access loans with more competitive rates and repayment terms. Personal loans Personal loans are typically unsecured and based on your personal credit history (not business credit). This can be a versatile financing option, but keep in mind that some personal lenders do not allow funds to be used for business purposes.Small business loans from online lenders Some online lenders offer similar loan options as a traditional bank, but typically have a faster approval process and may offer more options (though usually at higher interest rates) for people with lower credit scores.Business line of credit This is a short-term financing option that can be revolving or non-revolving in which you pay interest on unpaid balances.Merchant cash advance This financing option offers cash up front in return for a portion of a business’s future sales. Since they aren’t loans, MCAs do not require collateral and merchant cash advance companies typically won’t look at your credit scores to determine approval.Grants These are awards given by a government agency, foundation, nonprofit, or other entity, that typically don’t have to be repaid. Grants may be sector- or demographic-specific in their focus. For federal grant opportunities, Grants.gov and Challenge.gov are good places to begin searching.
The Takeaway
Loan, or debt-based, crowdfunding provides an alternative avenue to traditional bank loans. With this type of crowdfunding, offered by many peer-to-peer lending platforms, you are responsible for paying back the money from investors that funded your campaign, typically with interest. Loan crowdfunding may have more favorable terms, lower interest rates, and quicker approval times than traditional loans, but the amount you can borrow may be limited, and qualification requirements vary from one platform to the next.Interested in shopping around for a small business loan? Lantern by SoFi can simplify the process. Borrowers can explore options from multiple lenders with just one application.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. Photo credit: iStock/Chaay_Tee
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
