Crowdfunding for debt or equity:
What’s right for my company?
While recent data continues to show that banks are not meeting the demand by small companies for finance, more companies are turning to alternative forms of finance to meet the needs of their growing business.
With a market value set to reach £2bn, crowdfunding is proving an adequate supplier of early-stage finance and while there is plenty of information available about the products that each platform offers, for an entrepreneur new to fundraising, there are many questions that need to be answered. None more pressing than in determining which form of crowd finance is right for my company.
Peer-to-peer business loans are having their day and account for more than £1bn of the P2P industry in the UK. While some young companies who have been turned away from the banks may find they receive funding through a peer-to-peer loan, that does not mean that all will nor does it mean that this is the right choice for all companies.
When should you consider debt finance?
Debt financing should be considered when the money is raised for a single purpose over a defined period of time. Debt is best for companies that have both assets to borrow against and the cash flow to service the loans. Asset backed debt will help keep the rate down and the cash flow ensures late payments and the associated fees with them are avoided.
Debt is not ideal for companies that have tight cash flows and the regular repayments may place too much of an additional burden on the balance sheet. And, as with a loan from a traditional financial institute, don’t think that just because it’s a peer-to-peer platform your company is guaranteed to get funded.
Other forms of crowdfunded debt
Beyond peer-to-peer loans there are other forms of crowdfunded debt, namely the mini-bond. Mini-bonds work just like traditional bond in that the company issues a bond with intentions seeking to raise an amount and offers an annual interest payment on the loan for a set period of time, with the last interest payment paid along with a return of the initial investment.
The difference between these mini-bonds and traditional bonds is that there is currently no secondary market for investors to sell their bond to early.
From the company's perspective the benefit of issuing a bond over a loan is the ability to make less frequent repayments, though each individual repayment will be for a larger amount.
The upsides of equity
Equity financing through business angels, crowdfunding, or a combination of the two is often associated with early-stage ventures that are unable to raise finance through debt. Saying that, there are a number of companies who seek to raise equity for reasons other than sheer desperation. Bringing on a strategic investor is a great reason to raise finance through equity as keeping a healthy debt-to-equity ratio is generally considered best practice.
Equity is good for companies that already have raised a large amount of debt as raising equity does not require additional repayment to the lender. The negative side of equity is in giving up a certain amount of ownership to an outside investor. Young companies are often worried about giving up too much equity particularly at an early stage when the value of the business may not be high.
There are other forms of P2P funding that have not been discussed here. These are much more specialised types of finance and include invoice financing and hybrid forms of debt/equity.