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As a business owner, you may consider various forms of capital raising. Debt-based crowdfunding is a method of raising capital for projects or businesses that require funding. It is a type of crowdfunding where borrowers receive loans from multiple investors rather than just one lender. This fundraising method can benefit small businesses or individuals who may not have access to traditional lending sources. This article will explain debt-based crowdfunding and its advantages and disadvantages.
Debt-Based Crowdfunding Explained
Crowdfunding is a capital-raising method where many individuals contribute to the pot. There are many forms of crowdfunding, including:
- donation-based;
- reward-based;
- equity-based; and
- debt-based crowdfunding.
The focus of this article is on the latter, debt-based crowdfunding. This form involves several investors lending relatively small amounts to a business. The business will repay this money with added interest.
The process of debt-based crowdfunding involves the borrower creating a campaign on a crowdfunding platform that supports this method. They will detail the amount of money they require, the purpose of the loan, and the repayment terms. Potential investors will then review the campaign and decide whether they would like to invest in the project or business.
Forms of Debt-Based Crowdfunding
There are many sub-types of debt-based crowdfunding. These include the following:
| Type of Debt-Based Crowdfunding | Explanation |
| Peer-to-peer (P2P) lending | Peer-to-peer lending entails individuals lending directly to the business. Depending on the investment model, the company will either handle each individual investment (which can be challenging if there are many investors) or a single pool of funds. |
| Mini-bonds | Mini-bonds involve investors lending to a company for a fixed return over a set duration. For example, a mini-bond can have a 7% return rate over five years. This form requires lenders to pay interest at regular intervals. |
| Invoice financing | Invoice financing is a form of short-term borrowing that uses unpaid invoices as collateral for a loan. Business owners can receive a percentage of the invoice upfront from a third party. |
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Advantages of Debt-Based Crowdfunding
1. Alternative Form of Financing
Debt-based crowdfunding is an alternative method to traditional forms of capital raising. This method avoids the need for lengthy bank loan applications and approval times. Accordingly, it can be suitable for founders who cannot obtain such financing.
2. Interest is Attractive to Investors
The possibility of receiving a return on investment is compelling to potential investors. Debt-based crowdfunding may encourage more people to invest. A well-defined return on investment can also instil confidence in potential investors, demonstrating that the investment opportunity has been carefully considered and planned.
3. You Retain Ownership
Unlike equity crowdfunding, debt-based investments enable you to maintain business ownership. Debt-based crowdfunding involves borrowing money you will pay back with interest, whereas equity crowdfunding involves giving up a percentage of ownership in exchange for funding.
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Disadvantages of Debt-Based Crowdfunding
1. Cash Flow
Debt-based crowdfunding may not be suitable for businesses with unpredictable cash flow, as this can cause difficulty repaying your debt-based investors.
2. High Fees
Compared to other forms of crowdfunding, there can be higher fees associated with debt-based crowdfunding. Furthermore, the loan amounts can have a shorter term in contrast to other methods of capital raising.
3. Risks Associated With Investing in Debt
Debt-based crowdfunding comes with risks for both your investors and your business. You should carefully scrutinise any method of accruing debt before choosing it as a method of financing. There are significant risks associated with lending money, such as:
- there is no guarantee that your business will be successful and capable of easily repaying the debt;
- you will likely be liable to pay the debt if something goes wrong; and
- if successful, debt-based crowdfunding can be a slow form of investment.
Key Takeaways
Debt-based crowdfunding involves raising capital by accepting loans from several investors, typically through an online crowdfunding platform. This can take the form of many separate investments, or you may be able to pool the assets into one pot.
The advantages of debt-based crowdfunding include the following:
- it is an alternative to traditional forms of financing such as bank loans;
- the possibility of interest can encourage investment; and
- business owners retain ownership of their companies as the method does not involve issuing shares.
The disadvantages include the following:
- repayment of debt requires predictable cash flow;
- you may owe a high amount of fees; and
- there are many risks associated with accruing debt.
Debt-based crowdfunding will only be suitable for some types of businesses. You should carefully assess your business’s needs and explore various financing avenues to find the most appropriate form of capital raising.
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