How to Use Crowdfunding Loans for Your Business

Loan crowdfunding, also known as debt crowdfunding or peer-to-peer lending, is a potential source of capital for small businesses in which several 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 may offer better terms and 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 crowdfunding allows a business to raise capital by taking loans from several investors (lenders) who expect to be repaid for their loan (with interest) according to the terms the parties have agreed to. The entire process takes place through a crowdfunding platform.

By 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 beyond that.

What Are the Different Types of Loan Crowdfunding?

There are three main types of loan crowdfunding:

Peer-to-Peer Lending: Peer-to-peer (P2P) lending is when potential investors are matched with borrowers in search of capital. Depending on the loan amount and other factors, 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, their credit scores may be taken into account when interest is determined.

Microloans: Microloans involve individuals issuing loans directly to borrowers, but in smaller amounts. According to the U.S. Small Business Association (SBA), a microloan is anything under $50,000. However, many microloan platforms typically provide much smaller loans.

Invoice Financing: Invoice financing allows a business to borrow against unpaid invoices owed by clients. Some companies use platforms that allow investors to invest in individual invoices, letting the company access cash quickly without having to wait for the clients to pay. This process is sometimes called invoice trading, and there are fees involved, so companies typically get only between 70% and 90% of the full value of their invoices.

How Do You Find Investors?

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:

•   Funding Circle

•   Honeycomb Credit

•   Kiva

•   Prosper

•   SMBX

•   Worthy Bonds

Once you register with a platform, you will likely need to draft a pitch with the details of the loan you are looking for, such as how much you want to raise, the type and number of investors you’re looking for, what your business plan is, 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.

You may also need to provide some form of security, such as a personal guarantee or a business asset as collateral.

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 be from a bank. 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 can build a community that supports your business.

In contrast to other crowdfunding models, however, you don’t have to share equity in your company with the investors. This means that they have less of a say in how you run your business day to day. As long as you make your loan payments on time, you are generally able to run your business as you see fit.

Recommended: A Guide to Reward-Based Crowdfunding

Loan Crowdfunding vs Traditional Small Business Loans

It can be easier to qualify for loan crowdfunding than 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, you can simply try another, knowing that the application process will be different for each company. Bank requirements, on the other hand, tend to be similar no matter what institution you’re working with.

Just as with interest you pay on a business loan from a bank, the debt interest you pay to investors can probably be deducted as a business expense under your company’s tax return.

Recommended: Fees for Small Business Loans

What Risks Are Involved With Loan Crowdfunding?

Just as you would with any loan, you have to repay the crowdfunded loan with the agreed-upon 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 of 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 have a good track record.

Fortunately, crowdfunding loans are just one of the many types of financing options small businesses have. Other options include:

SBA Loans. The U.S. Small Business Administration (SBA) works to help startups and small businesses obtain loans. Instead of directly lending to the businesses, the SBA guarantees a portion of SBA loans, which can reduce risks for lenders and let startup businesses access loans with more favorable rates and repayment terms.

​​Personal Loans. Personal loans are typically unsecured and based on your personal credit history (not business credit). They can be versatile financing options, but keep in mind that some personal lenders do not allow funds to be used for business purposes.

Online Business Loans. Some online lenders offer loan options similar to those at a traditional bank, but they 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. A business line of credit is a short-term financing option that can be revolving or non-revolving. Typically, you pay interest only on unpaid balances.

Merchant Cash Advance (MCA). A merchant cash advance can provide cash upfront 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. Small business grants 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.

The Takeaway

Crowdfunding loans provide an alternative avenue to traditional bank loans for small businesses. They’re offered by many peer-to-peer lending platforms, and they require you to pay back the money from the investors who 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.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

Can crowdfunding be loan-based?

There are multiple types of crowdfunding, and yes, one of them is loan-based. Using a crowdfunding platform, you may be able to receive loans from one or more investors. You will typically need to pay these loans back, with interest, over a predetermined term.

What is loan-based crowdfunding?

Loan-based crowdfunding, as opposed to reward crowdfunding or equity crowdfunding, lets you ask potential investors for loans through a crowdfunding platform. With this kind of crowdfunding, you will generally be required to pay back the loans with interest according to preset terms.

Can I crowdfund to pay off debt?

You can crowdfund to raise money to pay off debt. Small business owners may try debt crowdfunding, which typically doesn’t have requirements as rigorous as those of banks, to raise funds to pay off high-interest debt. Then they can repay their crowdfunding debts, ideally at a more favorable interest rate.

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Photo credit: iStock/Drazen_

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