Gaining access to business loans is difficult for start-ups and small businesses. Many are forced to seek finance elsewhere. As awareness around alternative finance grows, is crowdfunding a suitable replacement for business loans?
Crowdfunding is a rising star of external finance. It has allowed many new products to enter the market where otherwise, they’d never receive the backing needed through traditional small business loans.
What Is Crowdfunding?
Outside the US, it is not known by many that the first and biggest ever crowdfunding ventures started in the 1880s. With the encouragement of the New York newspaper, The World campaign, was initiated to help raise funds to complete the Statue of Liberty project, which had been denied access to public funding.
In a little over five months, the newspaper had inspired over 160,000 New Yorkers to donate over $101,000 ($2.5m in today’s money) needed to finish the Statue of Liberty. Many donated less than a dollar, but the sheer numbers of donors meant the target was met and Lady Liberty remains an icon to those visiting New York today.
Crowdfunding today is little changed from the goals of the late 19th Century, although those offering funds to projects might now expect more financial or tangible rewards than a new addition to their skyline.
Modern crowdfunding efforts have seen enormous success, especially for tech products. For instance, the Pebble watch raised over $30m for its range of smartwatches.
This kind of success can only happen when a company raises its social and marketing profile in a way that builds interest and media coverage. For many companies, crowdfunding isn’t an easy way of generating the cash they need to achieve their entrepreneurial dreams.
For every Pebble success (and Pebble has subsequently ceased trading!) there are thousands of projects that fail to raise enough funding to get off the ground at all.
Then are also many projects that gain media attention for all the wrong reasons, like Zano, which raised £2.3m from over 12,000 backers and then crashed – leaving backers out of pocket with nothing to show for their investment.
Since 2009 crowdfunding has emerged as a popular and viable method of gaining funding for business, offering a unique way for entrepreneurs and business owners to gain rapid business growth.
Crowdfunding revenue has sky-rocketed, from $530 million in 2009 to over $1.5 billion in 2011. Since then, growth has continued to rise to the over $34.4 billion in 2015.
Do You Qualify For A Small Business Loan?
The best source of finance is a business loan from a traditional lender. But, for many new and small businesses, it isn’t always straightforward.
One of the reasons a small business might choose between crowdfunding and business loans is because they’ve already been knocked back for a small business loan.
The traditional banks also have a vigorous application process when it comes to agreeing on a loan. This includes a thorough analysis of your suitability for lending.
Business Finances
Lenders will assess all your accounting and financial information, to demonstrate your ability to repay the loan back.
Personal Finances
In the absence of a substantial trading history, your personal finances are pivotal.
Reason For Funding
You’ll need to explain the reasons for funding and demonstrate a plan of how you will use the money. This will provide a foundation for explaining how you will generate enough returns to ensure you can repay the loan.
Business Stability
You’ll need to show how your turnover and gross profits will be increased and that means having stable finances to start with. The lender will want to see core business stability from the outset.
The cheapest money to loan is usually from the banks and will invariably come with no strings attached, other than an agreed repayment structure. If you are lucky enough to have good credit, then either personal loans or business loans will be available to you.
For any business that already has an established footing, a business loan will nearly always be a preferable mechanism for funding.
Benefits vs Pitfalls of Small Business Loans
Benefits – If you qualify, you have a guaranteed loan with regular payments, no equity in the business needs to be offered to a third party and you know exactly where you stand, and for how long.
Pitfalls – It may have a strict lending criteria and can be difficult to qualify for. It can include a long application and underwriting process.
Is Your Business Model Suited To Crowdfunding?
Take a quick look at popular crowdfunding sites like Kickstarter. You’ll see the most popular and successful projects tend to be ones which offer a tech-sexy or a savvy marketable product.
According to one crowdfunding blog, the six biggest supported crowdfunding projects ever are:
– Pebble Watch (smartwatch)
– Coolest Cooler (cooler that does everything)
– Flow Hive (honey tap for your beehive)
– Baubax (travel jacket)
When a business pursues crowdfunding they are often happy with the all-or-nothing risks that come with it. For instance, you could spend weeks, or even months raising your profile and getting your friends and family to promote your product and still not secure any finance.
The key to crowdfunding is having your product so well-tested, that it speaks for itself.
Crowdfunding is still just a way of exposing your product or business to willing investors. They will only see it if you manage to conduct a healthy amount of marketing and promotion.
The bottom line for a crowdfunded business is that they tend to be either tech startups or based on products that may only have a short shelf life. Combining these with rapid investment can help the company generate quick profits.
But, because crowdfunding is seen as a great way of getting on board early for new product launches, existing small businesses might find it difficult to be heard above the noise.
Benefits & Pitfalls of Crowdfunding
Benefits – It can generate a lot of product hype before launch and attract multiple investors. Anyone can pitch for it and gaining funding can mean no large-level debts to be paid back.
Pitfalls – It is a high-risk all-or-nothing endeavour which exchanges investment for discounted or priority options further along the line. It also exposes you to making your business plans public property and can tie you in with having to justify your business decisions to third parties. Investors are only really interested in innovative branding and technology.
While crowdfunding can be a great way to generate a lot of buzz around your product (as long as you put in the required marketing miles) in a short period of time, it isn’t a guaranteed way to raise investment. Nearly every business that tries its hand in crowdfunding, will also be seeking to secure standard business loan options elsewhere as well.
Crowdfunding vs Small Business Loans
So which is right for your business?
Crowdfunding starts online and relies on getting money from as many individual investors as possible. Individual lenders must first be interested in your proposition as either a business or product. Sometimes you need to convince a lot of small investors, whereas occasionally it only takes a few big investors to contribute large amounts of funding.
If you don’t succeed in your target goal, you won’t be receiving a penny of those pledges.
Small business loans can be more straightforward. You only need to convince one lender of the viability (profitability) of your business in order to attain the full amount needed. Traditional small business loans have set terms for repayment and these are never negotiated after agreement, offering a fixed timeframe setting out equal monthly repayments.
A small business loan is a predictable and stable source of finance, which ultimately allows you to stay in control of your own business, without having to defer to shareholders or investors.
However, your qualification criteria (credit score/financial records) might prohibit you from obtaining a loan.
So, while crowdfunding relies on the meritocracy of your product and your business proposal, conversely the limitations of a business loan are rooted in the strict qualifying criteria of the underwriting.
Is Crowdfunding a Realistic Option for Small Businesses?
For many small businesses crowdfunding is the shiny new elephant in the room, tantalisingly close, but just out of reach. Crowdfunding platforms like Kickstarter or Indiegogo have statistics that don’t always make good reading for small businesses.
For Kickstarter, about 3 of every 5 new projects fail to attract enough support and on Indiegogo the number is even tougher, with just 1 in 10 managing to reach their fundraising goals.
Crowdfunding can be a realistic option for a small business if the product is a highly marketable one and you can engage and secure a huge number of initial backers.
There is a dark side to crowdfunding, not shady or underhand, but the very real fear that many businesses that take to crowdfunding sites do so with a motive, not to drum up huge amounts of financial backing, but as part of a high-level marketing plan for their new product.
And when success occurs, it can skew perceptions.
The mistaken belief is that crowdfunding is more successful than it actually is when viewed through the eyes of the media.
For small business owners, plenty of things can go wrong if you rely 100% on crowdfunding to get your small business project off the ground.
The Right Funding For You
There are both pros and cons for using small business loans and the same case can be made for crowdfunding. It is clear that the attraction of using crowdfunding lies in the difficulty many small businesses have in securing a small business loan in the first place. But, the real answer lies in what’s best for your business.
Certain businesses work well in the crowdfunding sector; those which offer really attractive, marketable products and businesses that are unable to gain finance from other sources, but which have a strong and tenacious marketing plan.
Small business loans work when you have a strong and stable business plan and a trustworthy financial history/credit score.
The benefits of crowdfunding have the potential to disappear when you are obligated to multiple shareholders, as your reputation will be on the line if you don’t come through on your initial promises to investors.
Crowdfunding is risky, it’s an all-or-nothing funding route, whereas small business loans offer clear payment terms. While there might be no limit to the amount of funding you can achieve through equity crowdfunding, you won’t be able to achieve anything like that level with a small business loan.
Crowdfunding has become a competitive marketplace and more will fail than succeed. But that doesn’t mean you shouldn’t consider its merits. If you’re unsure about what type of business finance might be right for you, get in touch with us for a free, no-obligation business consultation.
At Funding Guru, we specialise in finding finance others don’t look for, so even if you have had business loans turned down in the past because of a lack of solid trading history we might still be able to help.
