Understanding Crowd Funding vs. Traditional Lending

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Crowdfunding has opened up a new world of financing for business owners. With these online platforms, you can raise money through many small contributions from individuals, "the crowd." While crowdfunding offers some interesting benefits, it’s still not a replacement for traditional lending. Understand how both systems work so you can learn which is right for your company.

Crowdfunding vs Traditional Lending

There are a few different types of crowdfunding. One version is to take out loans, also known as P2P lending. Instead of taking out one bank loan, you take out many small loans from individuals. Lending Club and Prosper are two of the more popular P2P websites. Another way to crowdfund is to raise money through donations or presales on websites like Kickstarter. For example, if you develop an electric skateboard, you might give anyone who donates either recognition or a first release unit once you have hit your funding goal and finished production. Finally, you can also crowdfund by having people invest in your business in exchange for small shares of equity. Fundable and AngelList are two sites that promote equity crowdfunding.

Despite the growing use of crowdfunding, traditional financing still remains a popular option for business owners. When business owners think of traditional lending, they typically think of loans from major banks like Chase or Wells Fargo. However, there are other options like asset-backed loans, which are more flexible and better fits for small and medium sized businesses. While banks may handle these loans, specialty firms like Dwight Funding are better suited to help smaller businesses.

When Crowdfunding Works Best

Crowdfunding works best when your company is just starting out. At this stage, it can be hard for your business to qualify for traditional lending because you don’t have the necessary assets and revenue. You can still launch a crowdfunding campaign to raise some money for your company based on an idea and a compelling offer. Crowdfunding also markets your company, as people will learn about your business as you build hype around the crowdfunding campaign.

Crowdfunding makes less sense as your company becomes more established, after you’ve proved your concept and began selling. Launching a crowdfunding campaign can be fairly time consuming. You need to put together the campaign page and reach out to many small contributors. Even more frustrating, if you fail to meet performance goals, the crowdfunding website could cancel your campaign so you end up with nothing after all your work. When you’re starting out, you might have the time to take this risk but it’s not a smart investment as you get busier.

Another issue with crowdfunding is that you don’t receive any professional guidance for your business. The people contributing money won’t help you develop interpersonal relationships with other professionals or be able to contribute institutional knowledge, so you’re going to be on your own to execute your business plan.

In general, crowdfunding is great for product launches or to get first funding.

However, it isn’t a good option for growth financing or general working capital needs, the basic blocking and tackling after you’ve proved your concept and then need to scale for demand.

When Traditional Lending Works Best

Traditional lending works out better after you’ve been in business a few years.

At that point, you’ll have built up the business assets and financial history needed to qualify for these loans. Once you’re in this position, it takes less time to raise money through traditional lending because you’re only dealing with one lender rather than a large crowd of individuals. This process becomes even easier after your first loan because you’ll have an established relationship with your lender. Traditional lending is scalable as well. As your company expands, a traditional lender has the resources to grow with your business. Crowdfunding eventually reaches a limit in effectiveness. While in theory the amount of money you can raise is limitless, it becomes very difficult to find enough people when you need to raise larger amounts of money.  

Beyond money, a traditional lender can offer quality business advice as well. Chances are your lender will have helped similar businesses in your situation so their advice can be just as valuable as the loan. Finally, an established lender will have many other business contacts. Once you develop a relationship, your lender can put you in touch with suppliers and potential clients than can further your success.

However, all this only applies if you can actually qualify for traditional lending.

When your business is in preproduction and prerevenue stages, traditional lending might not be an option. Crowdfunding can help you bridge the financing gap as you work on getting established.

Both crowdfunding and traditional lending play a valuable role in the growth of companies. By keeping this information in mind, you can pick the right financing tool at every stage of your business.