Crowdfunding is not new, but new digital platforms have reinvigorated this democratic form of investment. With the banks reluctant to lend, we’ve seen a flurry of new businesses taking advantage. But which crowdfunding model is best: debt or equity?
Debt crowdfunding is just like any other loan: interest accrues on the amount you borrow, and must be repaid within a fixed term.
Debt is generally considered more attractive; you remain the sole owner of your company and have complete control. Once your debt is repaid, you are beholden to no one. However, debt repayments can hinder your progress, and if you don’t make a profit you will find yourself in a sticky situation.
The perceived security of your business affects the interest rate of your loan. If you have no assets against which to secure a loan, your idea is a bit ‘out-there’, or you’re entering a volatile market, your achievable interest rate may be prohibitive. Raising debt tends to be harder than raising equity; not many crowdfunding platforms offer debt.
Debt crowdfunding is best when confidence in turning a profit relatively quickly is high, and you have assets, other than the roof over your head, against which to secure your debt.
Think Dragon’s Den, the ultimate example of equity funding. It involves selling shares in your company to an investor, or in the case of crowdfunding, multiple investors. If you start making profit, you pay regular dividends proportionate to each investment forever after. However, you can go to shareholders for another cash injection if you get in trouble or want to grow, and if you go bust there’s no lender standing over your shoulder.
Both types of crowdfunding can give you access to advice from experienced professionals, but equity trumps debt if that’s what you’re after. Shareholders tend to have a real interest in your business and often expertise in your market; otherwise they wouldn’t have dared to invest.
The very fact shareholders are informed, sometimes respected, within your field, and will lend their insight, will help when finding contacts and building a market presence. Of course, they do own part of your company, and while they don’t get final say, you are obliged to engage with their advice.
Equity crowdfunding works well if you are able to secure key investors with relevant expertise. If you feel you could benefit from advice and visible sponsors, don’t want the pressure of debt repayments and aren’t expecting to turn a profit quickly, this could be for you.
The bottom line
You need to raise a start-up cost of £40,000.
A: You go with debt, pay fees of £1,600 and agree a fixed term of 5 years. With an interest rate of 6%, the cost of the loan is £8,255. With interest at 8%, it’s £10,610. At 10% it’s £13,033. After 5 years, the company is entirely yours with no repayments or dividends thereafter.
B: You go with equity and sell 15% of your company. Without profit, you don’t pay dividends. With £10,000 profit you pay £1,500 p/a, and after 5 you’ve paid £7,500. If you make £20,000, your dividends go up to £3,000; £15,000 over 5 years.
Equity might look more attractive as you never have to repay the £40,000, but you don’t own the whole of your business. If you’re only making £10,000, those yearly dividends will hurt. And let’s jump to the business you’re hoping for, with a profit of £50,000. Over 5 years you’ll pay £37,500, in 10 you’ll have paid £75,000, and so on.
Debt is generally better, but it can be hard to achieve. Equity is still a fantastic option with its own benefits. The most important thing is to get funded, and start your business!