debt crowdfunding

What is debt crowdfunding and why does it work for small businesses?

Debt crowdfunding serves as an alternative source of capital for small businesses without giving up ownership of their company and provides incentive for communities to get involved. Dive in to learn how debt crowdfunding works and why it's particularly favorable for small businesses.

Debt Crowdfunding for Small Businesses

As loan rates continue to rise, collateral needed to acquire a loan increases, and credit score minimums peak, debt crowdfunding continues to become the most viable option for small businesses looking for capital to grow or expand. Let’s take a deeper look at what debt crowdfunding is, how it works and the types of businesses could benefit from engaging their community in a campaign.

What is debt crowdfunding?

Debt crowdfunding is when a number of investors (a.k.a. the crowd) lend money to early-stage businesses or individuals through a regulated platform. Debt crowdfunding provides an alternative avenue to traditional bank loans, often with more favorable terms, lower interest rates, quicker approval times, and a simpler application process. So how does it differ from other types of crowdfunding? 

Equity crowdfunding gives investors partial ownership of a company if they invest in the equity crowdfunding campaign. Debt crowdfunding is more similar to a loan in which investors receive repayments on a fixed schedule with interest.

Reward crowdfunding provides investors with a reward, such as early access to the product a business is trying to produce, and no repayment in the future. Debt crowdfunding may include rewards in addition to repayments over time.

Determining Your Need

Before we jump into the types of debt crowdfunding that you can utilize to get capital for your business, it's important you determine your need. The best way to do this is by making financial projections. This will give you an idea of the money you need and how much capital your business can afford to contribute. You should also determine how much time it will take to repay the loan, the interest rate on the debt crowdfunding offer, what preliminary fees there are (if any), and what you want from your investors in return for loaning them money. Not sure where to start? Mainvest's Financial Projections Builder guides you through questions and creates financial projections tailored to your business.

Types of debt crowdfunding

There are a number of different types of debt crowdfunding, all of which benefit the borrower and investor in different ways.

Invoice Financing

Invoice financing allows small businesses to borrow against their debt owed by customers. Instead of affecting relationships with customers, invoice financing provides a way for business owners to get a revolving credit line that makes up for unpaid invoices and regain control over their cash flow. This being said, many small businesses may not have a significant amount of unpaid invoices meaning this type of debt crowdfunding would not allow for growth. 

Micro Lending

Often utilized to support non-profit organizations or underserved communities, micro loans are where individuals issue loans directly to borrowers. According to the U.S. Small Business Administration, a microloan is anything under $50,000, though many micro loan organizations, such as Kiva, provide much smaller loans. 

P2P Lending

P2P lending or peer-to-peer lending is similar to micro lending in that potential investors are matched with borrowers in search of raising capital. The one major difference is that the amounts are usually higher than micro loans and P2P lending often goes beyond supporting populations in need to servicing any individual or company in need of capital. 

How debt crowdfunding works

Debt crowdfunding is relatively simple and usually easier than obtaining a bank loan. Below, we lay out the process to get a bird's eye view on how debt investments work, from creating the initial offer or solicitation all the way to interest payments. 

  1. The potential borrower submits a proposal to a crowdlending platform ie. Mainvest.

  2. That platform then conducts a number of checks to judge the suitability of the raise for their website. These checks often vary depending on the regulations surrounding the particular funding portal each offering goes through. For example, here at Mainvest, we submit offerings with the SEC and Finra but do our own due diligence to ensure each offering is a viable investment solicitation.

  3. If the offering is selected to launch on the platform, the platform will offer the borrower rates of return and applicable fees that correlate with the risk level of the offering. Mainvest differentiates by allowing borrowers to set their own repayment terms and we only charge a fee if the offering meets its goal. 

  4. The offering is launched on the platform with a goal amount and time frame. Once launched, investors can choose the amount they would like to invest.

  5. The offering closes once timing runs out and the money is issued to the borrower. If the offering reaches its goal, investors will start receiving repayments in upcoming months. 

Why debt crowdfunding is great for small businesses

In addition to providing an easier, more affordable way to attain capital to start or grow, debt crowdfunding has community value not found elsewhere. Unlike reward crowdfunding, where investors only get a reward in exchange for their money, debt crowdfunding provides the borrower’s community with an investment opportunity in which they can get their money back with interest if that business succeeds. In turn, it allows investors to be involved in the success of a business they support. 

If you are a small business and interested in accessing capital supported by your community, click here to get started.

If you are an investor interested in supporting small businesses, click here to start investing.

Written by Lauren Murdock

Lauren is Mainvest's Content Marketing Manager. She is an expert in marketing strategy and leads content generation for Mainvest.

posted July 20, 2021
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