This article is a continuation of our “Business Financing” series, where we provide articles on the different funding options available for SMEs. So far, we have “The SME Guide to Business Financing” “How SMEs are Evaluated for Financing Suitability,” and “Traditional Financial Institutions vs Crowdfunding Platforms.”
Traditionally, financial options for SMEs are limited to bank loans, government schemes, and personal savings. In recent years, crowdfunding has emerged as an alternative for SME funding. Although crowdfunding is a relatively young concept, it has exploded into a phenomenon in the financial world. As a financing option, crowdfunding has proven to be particularly useful for small and medium businesses (SMEs)
Crowdfunding generally refers to the funding of a creative project or a business by a number of backers (funders) via digital technology. Crowdfunding has evolved into several categories, the most prominent of which are rewards-based crowdfunding, equity crowdfunding, and peer-to-peer lending (also known as debt crowdfunding).
In this article, we will take a closer look at the three categories:
Although there are different categories of crowdfunding, rewards-based crowdfunding is what typically comes to mind when one thinks of crowdfunding. It is one of the most famous forms of crowdfunding, pushed by the popularity of platforms such as Kickstarter, Indiegogo, and GoFundMe.
Rewards-based crowdfunding is an attractive fundraising option for artists in the creative field and for the development of new technology, especially for those with big ideas and compelling projects but no funds, since starting a rewards-based crowdfunding campaign is relatively cheap and easy.
A rewards-based crowdfunding campaign allows businesses and individuals to raise capital through online platforms. You post a project on an appropriate crowdfunding platform with a set amount of funds to raise. Anyone can contribute to a rewards-based crowdfunding campaign if they are interested in your project. In return for their financial contribution, you reward your backers. If you are pitching a video game, you can reward your backers with the right to create a new character. If you are pitching a film, you can offer exclusive sneak peeks.
While rewards-based crowdfunding isn’t suitable for projects that require a large sum of money, and exposing an idea online risks it being online, rewards-based crowdfunding comes with a set of advantages. The process is very simple and it is a cheap way of raising capital. Setting up a rewards-based crowdfunding campaign requires no collateral. In addition, you gain exposure for your project and feedback from donors and backers.
Currently, Kickstarter is the biggest platform for rewards-based crowdfunding, with more than US$ 2.5 billion pledged to Kickstarter projects, more than 100.000 successfully-funded projects, and more than 11 million backers. As proof that the crowdfunding concept is going global, Kickstarter recently debuted new branches in Asia.
In general, equity crowdfunding does not enjoy the popularity of rewards-based crowdfunding. Equity crowdfunding works by having a pool of investors fund businesses, usually startups with strong growth potential and compelling ideas, through online platforms. Equity crowdfunding is not loan-based. Instead, startup and business entrepreneurs trade shares of their budding companies in exchange for investor funds.
Like most crowdfunding categories, equity crowdfunding requires no collateral. Investors must do their research: what is the growth potential of the offered business? Will the business’ stocks increase overtime?
One may ask: what is the difference between equity crowdfunding and angel investors or venture capitalists? Angel investors and venture capitalists tend to be very wealthy individuals, perhaps even part of an investment group. A general investor does not have as much money as angel investors and venture capitalists. Equity crowdfunding promises to be more democratic – on platforms, accredited investors can invest alongside angel investors.
Equity crowdfunding requires no collateral and like rewards-based crowdfunding, gains exposure for your business with little cost. However, equity crowdfunding tends not to be for those who need to raise a vast sum of money. Some entrepreneurs choose to finance their business with equity crowdfunding first, then move on to angel investors.
Famous players in the equity crowdfunding market include AngelList and CircleUp. To learn more about equity crowdfunding and the statistics around it, check out this article.
A popular offshoot of crowdfunding, peer-to-peer lending utilizes online platforms to match borrowers and lenders. It’s also popularly known as debt crowdfunding. Borrowers take out a loan for working capital or other business necessities, while lenders who had collectively funded such loans earn interest-based earnings in return.
Peer-to-peer lending promises to be a win-win solution to all parties involved. Borrowers get to take out a loan with competitive rates and usually without a collateral, while going through a simple and speedy online process. Peer-to-business (P2B) is another variant of debt crowdfunding which primarily targets lending to small businesses or SMEs. Small business loan through P2B lending primarily targets the under banked segment in most geographies.
Lenders, meanwhile, can earn good return rates – higher than traditional investments such as bonds. While there are always investment risks, a good peer-to-peer lending platform would have performed through credit checks on borrowers. The concept of peer-to-peer lending is also easy to grasp and to start lending, the barriers are relatively low. Here at Funding Societies, you can invest with as low as S$100.
There are many debt crowdfunding platforms serving a variety of segments and target markets, from individual customers to business loans. It is particularly attractive to small-to-medium businesses. The lending platforms offer short-term loans, ideal for small businesses in need of a cash flow fix. Peer-to-business lending platforms can also be more flexible in assessing SMEs, looking beyond just hard data in financial statements. An applicant’s new projects, staff morale, director’s background, and the economic situation are all evaluated. Such loans requires no collateral, which is attractive to younger, smaller companies without suitable assets. To read more on how peer-to-peer lending can help SMEs, see this article.
Interested in applying for a peer-to-peer loan for your business? Click here.