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- Debt crowdfunding is when investors (the crowd) loan capital to a business in exchange for repayment plus interest over time.
- The process can be simpler and more convenient than taking out a regular business loan.
- Debt crowdfunding requires predictable cash flow to ensure paying back the loan on schedule.
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Starting or maintaining a small business requires capital. Unless you are flush with cash, self-funding isn’t a viable option. Options include traditional business loans, venture capital, Small Business Administration (SBA) guaranteed loans, and a relatively new phenomenon, debt crowdfunding.
What is debt crowdfunding?
Debt crowdfunding is growing in popularity mainly because, advocates say, it offers more favorable terms, lower interest rates, quicker approval times, and a simpler application process than other types of debt financing.
Crowdfunding involves convincing a large number of people to donate to or invest in a cause or business. Debt crowdfunding, one of the four main types of crowdfunding, is when the crowd lends money to a business with the expectation the loan will be repaid with interest.
Other types of crowdfunding include:
- Donation crowdfunding, in which donors give to a cause without receiving anything in return
- Rewards crowdfunding, which provides investors with a reward such as a product or service
- Equity crowdfunding, which gives investors a stake or a piece of ownership in the company.
According to small business non-profit, SCORE, debt crowdfunding loans typically have the following features:
- Loan amount: Up to $500K
- Length of campaign: Weeks to months
- Repayment: Monthly, 6 months to 5 years
- Loan APR: 5% to 27%
Among the most well-known debt crowdfunding platforms are:
- SMBX, a bond-based platform with a minimum raise of $25,000
- Mainvest, a loan-based platform with payments tailored to a fixed percentage of revenue each quarter
- Honeycomb Credit, which offers loans ranging from $15,000 to $500,000 with monthly repayment
- Lending Club a well-known platform that offers loans from $5,000 to $500,000 with monthly repayment.
Types of debt crowdfunding
Debt crowdfunding involves several types of crowd-based lending including peer-to-peer (P2P) lending, micro lending, mini-bonds, and invoice financing. There can be subtle differences within types, as Chris Rawley, CEO of Harvest Returns explains:
“Debt Crowdfunding takes on different forms. In the peer-to-peer model, individual investors are directly loaning money to a company. This can work for smaller loan amounts, but the burden to a company to service many small loans directly with retail investors can be a challenge. In another model, investors’ money is pooled into a special purpose investment vehicle, which loans money as a single entity into the borrower’s company. The advantage of this model is that the borrower is only ‘servicing’ a single loan writer.”
P2P or peer-to-peer lending matches businesses in search of up to $500,000 in capital to potential investors in search of healthy returns.
Micro lending is similar to P2P except the amounts borrowed are usually less than $50,000 and borrowers are often small distressed businesses located in underserved communities.
Mini-bonds have a term of three to five years, require borrowers to make regular interest payments to lenders during that time, and to return principal at the end of the term.
Invoice financing provides businesses with funding or a revolving line of credit based on money owed to them by customers.
How does debt crowdfunding work?
The debt crowdfunding process varies somewhat by platform but consists of several steps that generally follow this pattern:
1. Determine your need
Start by answering questions about your funding needs. Why do you need the money? How much do you need? How long do you require repay the loan?
Develop a proposal that answers these questions and provides a complete financial picture of your business or startup. Have this completed before choosing a platform and applying for a loan.
2. Choose a platform
In choosing where to seek crowdfunding, consider the experience, history, and track record of the founders and executives of the platform. Make sure the company is transparent about their business model, investment numbers, platform operations, and how they make money.
Find out how much you can borrow and how long your funding program can run. In this regard, Isaac Tebbs, head of growth at venture-backed startup, Millions, advises: “It’s important to have a realistic expectation of how much money you can raise through debt crowdfunding. You likely won’t be able to raise as much as you would through equity crowdfunding.”
3. Submit a proposal
Once you have chosen a platform, follow its instructions to submit your proposal. The platform will evaluate your proposal to evaluate your suitability. This could include a credit evaluation, submissions to securities regulators, and in-platform due diligence.
4. Evaluate the response
If your proposal is selected for launch on the platform, you will be given borrower rates of return and a list of any fees that apply. Fees and interest rates generally reflect the perceived risk level of your proposal. If you accept the terms, the next step involves launching your campaign.
5. Launch your campaign
Your campaign will be launched on the platform with a stated goal amount and time frame. Once the launch is announced, participants can choose the amount they would like to invest (often subject to minimums).
The campaign closes once time runs, out at which point you receive your funding and the repayment schedule is set in motion.
Is debt crowdfunding right for you?
At the top of the list of considerations when it comes to debt crowdfunding, according to Tebbs, is knowing who you are borrowing from.
“Some platforms are focused on consumer debt, while others specialize in helping businesses raise money from accredited investors,” Tebbs says. “You need to know who you are borrowing from, or you’ll fail.”
In general terms, you should consider the benefits and drawbacks of this type of funding to determine if it’s a good fit for your business and your needs.
Pros and cons of debt crowdfunding
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Alternatives to debt crowdfunding
Debt crowdfunding is an alternative to traditional business funding, but it’s not the only one. Another funding alternative is fintech funding, a type of venture capital alternative in which fintech financial service companies provide loans, typically in specific areas such as agriculture, consumer goods, and restaurants. Fintech funding features fast turnaround of loans and often includes high-tech analysis and machine learning.
“Every entrepreneur looking for funding is facing their own unique set of challenges,” says Nick Brown, president of fintech funder, Circle Up Credit advisors. “Crowdfunding campaigns can come with friction due to the time it takes to ramp up, no guarantee of funds, and the lack of scalability to grow the fund as the business grows.” Other alternatives to debt crowdfunding include:
- Equity Crowdfunding: Bestows ownership (shares) on investors instead interest on a loan
- Grants: Consist of financial assistance awarded by the federal, state, or local government that does not have to be repaid
- Venture capital and angel investments: Come from firms willing to fund startups in certain industries (tech, medical, internet) that are considered disruptive in their space
- Convertible notes: A form of short-term debt that converts to equity after a conversion event occurs (usually when the startup raises a new round of funding)
- Revenue based financing: A type of financing in which specialized lenders provide capital to an early-stage business and get paid back as a percent of future revenue
- Bootstrapping: A traditional type of alternative funding that consists of a variety of funding attempts including friends and family, service or product presales, using your savings or selling assets, and even looking into lines of credit.
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