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Banks, Lenders & Investors Business Development & Marketing Factoring, Invoice Discounting & Asset Finance Finance General

Is raising finance from debt crowdfunding a good idea?

In the second in our series on crowdfunding we’re focusing on debt crowdfunding, also called Peer to Business lending.
Typically lenders are looking to finance tangible assets that they can secure, such as book debts, vehicles or plant & machinery. However all too often businesses want to finance business growth which might involve business development, staff or simply working capital. The banks have largely withdrawn from such funding unless security can be provided. As a result there is an explosion of crowdfunding with most models based on loans.
In the debt crowdfunding model most loans are based on compounding interest with equal monthly repayments for the duration of the loan which is normally for between 2 and 5 years.
According to Nicola Horlick, chief executive of Money&Co, writing in CityAM in April 2015, debt crowdfunding is the source of funding for the vast majority of UK SMEs. She argues that this type of crowdfunding is less risky than equity crowdfunding because of the high failure rate of start-ups, whereas a debt funder like herself will ask for several years of made-up accounts.
Funding Circle is probably the best known debt crowdfunder in UK. It has loaned about £750 million to 7,300 businesses in UK and US. Examples include Blood & Sand who borrowed £104,000 in October 2014 from 100s of individual lenders to refurbish their new cocktail bar in London.
Given the risks, such loans are not much cheaper than those from a bank but they tend to be easier to obtain. However despite the perception of an easy loan, most funding platforms rely on directors giving a personal guarantee so as to make sure that they have every intention of repaying the loan.

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Banks, Lenders & Investors Cash Flow & Forecasting Finance General

An overview of crowdfunding

Funding for businesses and in particular those wanting to invest in development and growth has become extremely difficult to find. Banks have become risk averse and need evermore capital-liquidity provisions which has combined to make it uneconomic to lend to SMEs and those who can’t provide asset backed security.
This has led to the popularity of raising money using online via crowdfunding platforms.
Crowdfunding can be defined as the act of raising money via a website from a relatively large number of small investors.
This is a fairly new form of financing and the last two years has seen some clarity emerging as to the different types and what each involves.
In our next few blogs we will be looking at each type of crowdfunding. This first article is a short overview.
There are three main types of crowdfunding. They are Equity, Debt (aka peer to business or market place lending) and Donation (aka Reward) crowdfunding.
In the first, individuals provide capital for shares in the business looking for funding and expect to receive dividends and/or a profit from a future sale of the shares. They are typically used by start-ups, early stage & growth businesses.
In the second type, Debt crowdfunding, businesses are looking to borrow money as repayment loans, convertible loans or loans with warrant. Lenders are typically repaid at regular intervals with interest on terms that are often more competitive than can be achieved from a bank.
Donation crowdfunding is generally used to raise non-returnable money for a worthy cause, so there is a social component and the “reward” is generally in the form of recognition for investors’ contribution rather than any financial return.
There has been some concern that small investors in such schemes may be inexperienced in investment and its risks and this has led to the introduction of regulation via the Financial Conduct Authority (FCA) in an effort to protect them.
Since April 2015 any organisation offering Equity or Debt crowdfunding facilities must apply to the FCA for permission to operate and must supply supporting evidence including a detailed business plan, evidence of capital reserves, a website showing information that details not only the benefits but also the risks involved.
The FCA is responsible for regulating loan-based and investment-based crowdfunding such that only regulated firms should be used to raise finance. The main restriction relates to the marketing promotion to investors in Equity and requires each investor to acknowledge they are either a high net worth or sophisticated investor or to confirm that they will invest less than 10% of their assets in crowdfunding. This means that firms raising Equity should take advice before doing any self promotion of Equity crowdfunding.
The FCA does not regulate Donation crowdfunding.
For other sources of business finance you can download a free Finance Guide from our website using this link.