Crowdfunding and peer-to-peer lending are two of the popular ways in which founders raise capital for their startups. Each has its advantages and disadvantages.
Unfortunately, many startups would have to learn this the hard way.
Crowdfunding and peer-to-peer lending are popular alternatives and have opened up new opportunities. They are both used by startup founders who weren’t successful in raising capital through traditional channels like applying for bank loans and grants.
This article explains the difference between crowdfunding and peer-to-peer lending and which one you should choose for your startup.
What is Crowdfunding
Crowdfunding takes place by pitching the concept to as many people as possible; it reaches out to everyone through digital marketing. This is achieved through social media, online advertising, or online groups.
If you’re new to startups, you would want to pitch your idea to potential investors. Contacting friends, families, investors, and corporations is one way to do that. Otherwise, you could have modern technology to do that for you.
Crowdfunding uses small amounts of capital from many people to finance a business venture. Crowdfunding uses the easy accessibility of various individuals’ networks through social media and crowdfunding websites to bring investors and entrepreneurs together. This will increase the opportunity for entrepreneurship by expanding the pool of investors outside the traditional circle of owners, relatives and venture capitalists.
Advantages of Crowdfunding
1. You Don’t Have to Worry About Upfront or Recurring Fees
Investing in a crowdfunding campaign is easy. You don’t have to worry about upfront or recurring fees because investors can invest directly online in a project or business.
2. Allows You to Market Your Startup
An active crowdfunding campaign is a great way to introduce a venture’s overall mission and vision to the market, as it is a free and easy way to reach multiple channels.
Many crowdfunding platforms have frameworks for social media mechanisms, making it easy for the website and other social media accounts to get referral traffic.
This usually enables ventures to receive thousands of organic visits from unique users and prospective funders. These users are also significant for viral marketing, as they can share and spread the word to their connections.
3. Gain Guidance from Experts
By sharing your idea, you can often get feedback and expert guidance on how to improve it.
4. Get Feedback from Your Target Market
For small companies and startups, one of the biggest challenges is to plug all the gaps that a company may have at an early stage.
By having a crowdfunding campaign, you have the potential to engage the audience and collect suggestions, feedback, and ideas. This feedback is essential, as it can help understand some aspects of their business that were previously unthought and unheard of.
Disadvantages of Crowdfunding
1. All-Or-Nothing Approach
Some crowdfunding platforms will return the funds a startup raised to investors if they don’t reach their target amount. Any funds that have been pledged will usually be returned to your investors, and you won’t get anything.
2. Requires much Work for Your Crowdfunding Campaign to be Successful
Launching a successful crowdfunding campaign involves a lot of moving parts.
If your startup is still in the Idea or Pre-Seed stage, you may not have the resources to develop and launch a crowdfunding campaign. You need to do much work in building up interest before the project launches – significant resources (money and/or time) may be required.
3. Risk of Breeding Copycats
In contrast to traditional ways of raising finance, where there are several possible investors to whom a business presents its ideas, crowdfunding involves many individuals knowing a lot about the business and its concept. As you publicly give all the information about your product, your ideas can be copied and quickly replicated before you even offer the final product.
Because of this, you need to get the right intellectual property protection for your ideas before posting your campaign online. This may appear as a trademark, patent or copyright. You should also read the legal disclosure on your chosen crowdfunding platform and get legal advice before publicising your ideas.
4. Lose Control of Your Business
Getting the rewards or returns wrong can mean giving away too much of your business to investors. Giving away your startup’s equity to an investor means that these investors now have a say on how your startup should be run. If you keep giving this away, the time will come when you will eventually have to follow what their investors want because they own most of your startup’s equity.
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer (P2P) lending is a fast-growing type of finance in the UK It works by connecting lenders and borrowers through traditional brokers or online platforms. You fill out an online application, providing information on your business and how your business will use the loan, the amount you wish to borrow, and how long you need the money.
You might get the loan in a few days if the decision is made practically instantaneously on some P2P platforms.
However, you might first have to pay an arrangement fee to the P2P platform to acquire a loan. The loan is then repaid with interest during the loan agreement through consistent instalments.
Advantages of Peer-to-Peer Lending
1. Retain Full Control of Your Startup
There’s no obligation to surrender ownership of part or all of your business, as with other types of finance.
2. Quick and Straightforward Processing
The lending process is easy and direct, and decisions are made quickly, meaning you receive the money with little or no delay, unlike traditional loans.
3. Assistance to Startups in Challenging Times
Due to the lack of collateral and the more lenient credit requirements, P2P lending is a viable option for consumers who need to borrow money during times of crisis. And in some cases of consumer loans, P2P lending is used for debt consolidation.
Disadvantages of Peer-to-Peer Lending
1. High-Interest Rates
P2P Lending may have higher interest rates than traditional company loans. It’s possible that the person or company you lend money to won’t repay it (also known as “defaulting”).
The higher the default rate on a P2P website, the higher the number of people or businesses that can’t repay their loans.
2. Can Potentially Affect Your Credit Standing
Peer-to-peer loans are exposed to high credit risks. Many applicants for P2P loans have poor credit histories that prevent them from getting a traditional loan from a bank.
As a result, you need to be aware of the likelihood that your counterparty will default.
3. Puts Your Entire Startup’s Capital at Risk
Startup founders can lose capital that was raised through other means if they default on their payments. There is no insurance or government protection, which means that the government doesn’t provide insurance or any form of protection to the lenders in case of the borrower’s default.
Also, if you fail to repay a peer-to-peer loan, the provider may pass the debt on to a debt collection agency or take you to court.
How to Choose Which Capital-Raising Option to Use
1. Analyse Your Startup’s Current Financial Health
Startup founders need to determine their startup’s current financial health – whether they can afford regular loan repayments and how much they can afford to pay back.
For instance, peer-to-peer lending is best for service-based small businesses because of their competitive interest rates compared to many online loans, while crowdfunding does not need to repay investors and has no credit or revenue requirements.
2. Determine How Much Capital You Need to Raise
Crowdfunding has a more significant risk than P2P, but it may be argued that the benefits offered to reflect this. Peer-to-peer lending provides more predictable returns, with comparatively lower risks and returns.
3. Level of Urgency
When choosing your capital raising option, determine if you need the funding right away or can afford to wait a while to receive the funding you need to raise.
Crowdfunding usually takes significantly longer to complete than P2P lending. It frequently takes a month or longer, whereas P2P lending can deposit money into your bank account within a week of receiving your application.
4. Willingness to Share Ownership of Your Startup
Through equity crowdfunding, your investors will receive a particular amount of equity in your company, meaning they get partial ownership. Aside from company ownership and a share of the earnings, they also get control over company decisions.
Meanwhile, peer-to-peer lending functions exactly like traditional financing. If you take out a P2P loan, you must repay it in full with interest and fees.
To ensure that your loan is repaid within the loan term, your P2P lender will set you up with a repayment schedule (which can range between a few months to many years, depending on the lender).
Summary
Crowdfunding and P2P lending are great options for raising capital for your startup. But while they both let you receive funding from individual investors, they work quite differently.
We hope this guide helped you choose which one to use to raise your startup’s funds.
