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What is Debt Crowdfunding?

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Loans are always a big part of building or maintaining a business. When cash flows cannot be sourced from a single person or a set of parties to jump-start a company, most proprietors rely on lending money from investors to be able to generate capital to broaden checks and balances, creating a way for a company to expand through the financial help from such entities. When loans are an inevitable part of a business structure, more and more companies, whether big or small, make funding work by paying interest and doing collaterals, to be able to have leverage when it comes to paying.

One of the most common types of financing is Debt Crowdfunding. This lending system involves reaching out to a crowd of donors and investors, where they will lend money to a business though usually small, and expects it to be returned with interest over time. Moreover, contrary to seeking finance in big amounts, this type of financing involves ordinary to medium types of crowds, where interest rates are low, terms are favourable, risks are low, and the application process is typically easier. Also, debt crowdfunding does not guarantee ownership to the lenders once they can finance, and only pays them through interest above the principal borrowed. Still, it keeps the costs down for the borrower, as they can skip the middlemen in the transaction, and seek financing directly from the lenders.

Nonetheless, debt crowdfunding as another type of lending can be paid in variations – some platforms may ask for a bond that guarantees a fixed interest in a fixed term, and others may also come to terms with peers to avoid big interest and have a financing scheme that relies on personal relationships, and others might even sell updated invoices to technically not give cash to the business but consequently have products and services paid on the company’s behalf. Yet, the common ground with the different varieties is that they come for small entities in bigger groups, rather than lending a big capital from one or two lenders only.

Types of Payments for Debt Crowdfunding

Mini-Bonds

Mini Bonds are not the most used type of crowdfunding. While this comes as another payment term for small loans, it is not sought by borrowers; the main reason is that mini-bonds require borrowers to pay a fixed return over a set period of time of 3-5 years, with the initial investment and a part of the interest paid at the end of the term. For borrowers, this can be risky as markets can go up and down, hence, paying in fixed interest can be quite demanding, but it can be beneficial too as it can beat inflation. Yet, this can be an advantage for lenders; as there will be a fixed payment every month for years, it guarantees payments that stick to the agreed interest, and thus a stable return for them. Hence, this payment term is not flexible, as the lenders cannot withdraw the borrowed amount before the end of the term, and the borrower cannot pay in advance to waive the bond payments for the remaining term.

Invoice Financing

This type of payment does not require a direct investment from the company, but technically it makes the lender pay for a product or service on behalf of the borrower company. This sets an irregular cash flow for the borrower, but still, an advantage as the invoice can work as collateral for them and pay the outstanding debts to suppliers. Consequently, payments are also done in a fixed term, with interest rates on top of the principal. This, on the other hand, may only rely on small lending companies, in a way that small and medium enterprises can benefit with only a little interest than borrowing funds from big financing companies which also require bigger interest rates and a standard amount of invoice.

Peer-to-peer Lending

As the name says, peer-to-peer lending is a crowdfunding system that works via financing without the need to use the bank as an intermediary. As banks have heightened their criteria for loan approvals, a lot of Kickstarter or SMEs have relied on financing from groups of people, often used to cut costs on processing fees by the middlemen. Nonetheless, individuals who contribute to the funding are repaid in gifts, products, interest payments, and sometimes equity of shares. However, this type of crowdfunding has a downside; it does not guarantee that the lender will be paid, as it just relies on how the borrower’s business will grow. Thus, can be classified as a donation to a new or established company, where it usually pitches to a crowd for small funds that can generate cash flow eventually after everything is added.

Crowdfunding is an advantage for SMEs and Kickstarters, as it does not have strict rules when it comes to applications. It crushes out intermediaries between borrowers and lenders, cuts down costs, shortens the application process, and approves jumpstarts and SMEs to have small funding but in bigger batches. All the more, it helps borrowers avoid giving up equity, validates ideas to propel the business, and provides flexibility when it comes to finances – therefore a quick way for small businesses to lend money when capital may fall short than expected.

 

 

 

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Written by Aiza Day

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