If your business is very small, young, or not even "started" yet, getting your hands on cash can feel like mission impossible.
This dynamic has led to an influx of new, non-traditional lenders hoping to meet the demand. There are now more than 44 different types of business financing available.
On general, having more options is a good thing, but figuring out what’s right for you can spell trouble. Many businesses have failed simply because they got stuck paying back a loan that they couldn’t afford.
One of the “newer” financing options growing in popularity is crowdfunding. The crowdfunding market grew by 167 percent worldwide in 2014, with $16.2 billion raised. Although you may consider it as a modern financing source, it’s actually existed for a long time. Authors and publishers have used it for decades to fund new books via readers who pledge to buy it before it’s released.
Related Article: 5 Reliable Tips for Selecting the Right Business Loan
How Does Crowdfunding Work?
Simply, crowdfunding is a way a to fund a project or business venture through a series of small donations, or pledges, from multiple individuals or investors. In return, you usually promise to provide one of your products or equity in your business. It can be especially useful if you’re financing a new project or idea. You’ll not only validate market interest before sinking money into the project, but it can also save you from the dreary work of fundraising.
To give you a better idea if crowdfunding may be right for you, let’s do a side-by-side comparison with a familiar financing option, the traditional business loan.
|Financing Originator||The bank or online lender from which you apply for the loan.||Funds are issued by the crowdfunding platform that hosts your campaign, but the money comes in the form of pledges from several individuals or groups.|
|Application & Approval Process||
Banks will typically review your credit score, tax returns, financial statements and business plan before approving the loan. Approval can be difficult.
Campaign requirements and guidelines can vary from platform to platform, but the process is typically faster than bank loans.
|Credit Requirements||Typically, business loans require good personal and business credit scores.||There are no credit score requirements associated with crowdfunding campaigns.|
Loan repayment come in the form of monthly installment (principal and interest) until the loan is paid in full.
Penalties and fees are assessed for delinquent payment or loan defaults.
You are not required to repay the funds raised for your crowdfunding campaign.
|Interest & Fees||
You pay interest on the total amount of the loan.
|Crowdfunding platforms will typically charge a one-time, percentage-based fee upon the disbursement of funds.|
|Banks issuing business loans often provide business owners with guidance or mentorship resources.||Some crowdfunding platforms give you access to investors and any advisement or mentoring they can offer.|
Still not sure what’s best for you? Here are some more pros and cons of both options.
Pros and Cons of Crowdfunding
Since crowdfunding success depends on you enticing individual investors or investment groups to rally around your idea, it will let you preemptively tap into your potential market base before you start your business rather than after.
This means you can test the waters on your idea before you invest further time and money into it. If there isn’t enough appeal, your campaign won’t take off, you won’t have access to funds, and you’ll be able to go back to the drawing board.
However, crowdfunding does require a lot of upfront effort and manual labor on your part, and it’s always possible your campaign won’t succeed and it will all be in vain. To draw in pledges, you’ll need to have a strong, multi-faceted marketing plan. Furthermore, you’ll need to keep up on administrative work such as corresponded and investor follow-up.
Pros and Cons of Traditional Loans
On the other hand, traditional bank loans may come with strict application/approval requirements and carry a bit more risk up front (i.e., it’s not always possible to gauge interest before going all in), but the cash is yours once you’ve been approved and making on-time payments can help build your business credit.
It’s also worth mentioning that, unlike equity crowdfunding, which requires you to provide investors with equity in your company once a business loan is paid in full, ownership of your company is entirely yours.
At the end of the day, only you’ll know which option better aligns with your specific situation and goals aligns. Thoroughly research each option and consult with a small business advisor or mentor to help if needed. Many advisor programs, like local Small Business Development Centers, are free to use. Take advantage.