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The Basics of Debt-Based Crowdfunding

Source: 401kcalculator.org

Source: 401kcalculator.org

Attaining funds is a critical step for many entrepreneurs. Fortunately, innovative concepts like crowdfunding, where funds are collected from a large, dispersed pool of investors, have provided entrepreneurs with alternatives to traditional funding sources like financial institutions and venture capitalists. According to an industry report, in 2015, the global crowdfunding industry surpassed $34 billion in estimated fundraising volume. In conjunction with the increase in crowdfunding transactions, crowdfunding sites have multiplied. These sites come in a variety of different forms and provide entrepreneurs the ability to customize their funding campaigns. Common types of crowdfunding sites, in their simplest form, include:

Equity-Based – investors receive a portion of the company in exchange for funds

Reward-Based – investors receive goods or services in exchange for funds

Donation-Based – individuals provide contributions

 

While these three types comprise a large sector of the crowdfunding market, entrepreneurs and investors also commonly use debt-based sites, which accounted for $25 billion in estimated fundraising volume in 2015. In a debt-based crowdfunding transaction, rather than receiving equity in exchange for capital, investors receive a debt instrument, often in the form of a note or bond, with a fixed repayment term and a specified rate of interest. Most debt-based sites are free to register and require borrowers to submit financial information before receiving a customized interest rate and credit risk. Entrepreneurs favor these sites because the interest rates are often lower than or competitive with interest rates at traditional financial institutions. It is important to keep in mind that this type of crowdfunding campaign is not for every entrepreneur. Rather, it is particularly advantageous for entrepreneurs who have difficulty meeting market demand for their service or product.

Debt-based crowdfunding has been described as a “win-win” because it provides investors with a relatively low-risk return and entrepreneurs with the ability to retain equity. However, one inherent risk to investors is the fact that these loans are often unsecured and leave little recourse in the event of default. The growth of the crowdfunding industry has alleviated some of these investor concerns, as several debt-based platforms boast impressive track records. Three examples of such sites include:

 

Lending Club:

  • Founded: 2006
  • Total Amount of Loans (individual loans and business loans): Over $20 billion
  • Interest Rate Range: 5.32–30.99%

Funding Circle:

  • Founded: 2010
  • Total Amount of Loans: Over $2 billion
  • Interest Rate Range: 5.49–27.79%

Prosper:

  • Founded: 2006
  • Total Amount of Loans (individual loans and business loans): Over $6 billion
  • Interest Rate Range: 6.88–31.10%

It is undeniable that debt-based crowdfunding has experienced a dramatic growth over the past decade. Yet, citing a limited pool of investors and an influx of loan applications, critics warn that perhaps the “novelty” of debt-based crowdfunding is coming to an end. It remains to be seen whether this is the case.

For now, because the laws concerning crowdfunding remain in flux, entrepreneurs should stay informed. Visit the following links to learn more about crowdfunding:

CrowdFund Intermediary Regulatory Advocates

Crowdfund Insider

Crowdnetic

Crowdfund CPA

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