The Crowdfunding Comparison Every Startup Needs To Read
Funding ain’t what it used to be. Rather than bank backing or venture capital investment, startups today have the opportunity to mix and match a range of alternative investment options to get their business up and running. Case in point: crowdfunding. It isn’t just asking friends and family for their support, but rather a variety of types with differing guidelines.
Choosing the right crowdfunding campaign is a delicate decision for each and every startup, with the majority of contemporary businesses selecting equity crowdfunding through platforms like Wefunder. However, debt crowdfunding investment is also becoming an option for those founders who do not want to give up part of their business for backing. Nonetheless, both have benefits and drawbacks to carefully consider, from gaining industry partners to putting up collateral against lower repayment rates.
You Scratch My Back, I Scratch Yours
Crowdfunding is not free funding from the public – at least not in the world of business and startups. Non-charitable crowdfunding campaigns usually include an incentive for investors to put their money where their mouth is. Equity crowdfunding is one example: Investment entitles the backer to part of the business. Platforms like Wefunder and Seedrs show that this can and does work for both sides of the investment agreement – but must be entered into with a solid understanding of the pros and cons of such a deal.
The best part of equity crowdfunding is that startup founders are not required to put up their personal assets as collateral. Furthermore, the backing from investors and industry insiders will offer knowledge and contacts to strengthen the business as a whole – in essence, equity crowdfunding partners grant a world of ambassadors.
On the flipside, equity crowdfunding means founders must give up a stake of the business to secure investment. This means control and profit sharing must be considered. Since there is much more sharing of risk in this type of crowdfunding, satisfying investors to commit can be more difficult. Each and every equity partner literally needs to “buy-in” to the company vision. This can be especially difficult for startups with a niche concept or working in a specialized industry.
Keep Company Capital But Remember The Collateral
While popular, equity is not the be-all and end-all in the crowdfunding discussion. In fact, more startup founders are unlocking the potential of debt crowdfunding to realize their business goals without giving up a stake in their startup. See FundingCircle, OnDeck or BondStreet for this in action, but again there are positives and negatives to such an arrangement.
In this style of crowdfunding, founders are not required to give up part of their company to secure funding and the shares will not be diluted. If the startup later becomes very profitable, the startup simply needs to pay back the debt and remain in control of the profits. Alternative collaterals are something to consider.
Collateral is the major con here. Inherent in debt crowdfunding is collateral to back said loan. The logic is that this money will be paid back as long as the collateral is agreed upon – but this can be more difficult with startups which may not have something to collateralize.
Further, the founder might use their car, house, investment – ultimately it is negotiable. It is important to keep in mind that with solid collateral, the interest rate will be lower. The higher the risk, the higher the interest rate – and collaterals influence the risk rate of any given loan.
Let’s Talk Investors
It is worth putting the startups to one side to consider what this new paradigm means for the investors. Rather than simply venture capital, investors have a world of options at their disposal. Between the two crowdfunding options previously discussed, investors are less at risk to invest in debt crowdfunding rather than equity crowdfunding. This is since there is at least something agreed upon for collateral to return the investment no matter what happens.
This is not something that would ever be backed by a bank. Debt crowdfunding is connecting entrepreneurs with potential investors who are keen to connect with alternative investment but not as keen to embrace risk as equity investment.
These are exciting times for investors as there are simply more options available than ever. Crowdfunding through equity or debt should be seen parallel to the stock market. Investors have the option to invest in stocks (equity) and bonds (debt), diversifying options and exposure accordingly.
The Best Combinations For Startups
The fact of the matter is that most startups will probably find a mixture of both equity and debt as the best option for their business. A healthy balance between equity and debt makes a better equation – for example, if the startup has too much debt it will become very expensive, while if they give away too much equity they might lose control and reduce long-term profits.
There is no escaping that with more ways of financing, startups need to tap further into financial engineering to understand their best possible return and long-term objectives. Whether debt or equity crowdfunding is the calling, the economic reality remains. This means to extinguish the debt as soon as possible or to partner with investors and keep them for life. In both cases, startups can succeed – but strong economic understanding is key before taking the crowdfunding plunge.
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Source: Startus Magazine
Author: Max Lydavinsky