While there’s been a lot of talk in recent years focused on equity crowdfunding, debt crowdfunding is a unique (and often overlooked) strategy that can help companies fulfill their fundraising needs. Yet many business owners are unfamiliar with this type of crowdfunding, or mistakenly assume it’s just a different name for equity crowdfunding.
However, debt crowdfunding is a vastly different model than equity crowdfunding and, if used properly, can create a strong and stable economic environment that will allow your company to flourish and grow, without having to give up any type of control.
What is debt crowdfunding?
Debt crowdfunding is similar to equity crowdfunding in that investors contribute to your project. However, these investors’ contributions come in the form of a loan, rather than as a donation or in return for equity.
As with any type of loan, with debt crowdfunding, investors will be looking for a return on their investment, in the form of interest. These forms of interest can include:
- Convertible loans
- Invoice financing
Is debt crowdfunding right for my company?
Debt crowdfunding can be attractive to investors who want a fixed return (making it easier for financial planning purposes). As a result, debt crowdfunding investors are looking for specific elements in a company to protect against the potentiality of the downside. If your company can offer these elements, then you might be a good candidate for debt crowdfunding.
Investors are looking for:
- Assets (in the form of company premises and equipment)
- Between 1 – 3 years’ worth of history and accounting records
Understanding this, it’s clear that debt crowdfunding is likely not the best option for startups. The reality is startups are risky (nearly half fail), which makes them unattractive for investors looking to get any type of return. If you’re just getting started with your company, your time is best spent looking at other fundraising channels.
On the other hand, established companies (with a steady and established cash flow) are far more attractive to an investor looking to make a return based on interest.
When should I consider debt crowdfunding?
An established company looking to expand will likely come across obstacles when raising capital for expensive things like acquisition financing. Banks, for example, set unfavorable repayment rates and aren’t likely to offer any type of reduction. This makes it an unattractive channel for most small companies to pursue.
But debt crowdfunding is designed to empower company owners since these owners can set the interest rate on any loan repayments as part of their “pitch.”
Equity crowdfunding or debt crowdfunding?
Companies looking to expand might turn to equity crowdfunding first to raise capital. However, what they might discover upon closer inspection is that they’ll have to give up some control to their new shareholders, in the form of voting rights.
Debt crowdfunding, on the other hand, doesn’t require the loss of any voting rights. Thus, if your goal is to raise capital while retaining complete control over your company’s operations, then debt crowdfunding may be your best strategy.
Nate Nead is a Director at Merit Harbor Group, LLC, an investment bank focused on the lower middle-market. Nate’s practice expertise ranges from oil & gas to software and technology. He holds a keen interest in financial technology where he believes there is a democratization taking place, particularly with some of the new crowdfunding opportunities available.