When starting a business, business loans
and crowdfunding are two popular options
entrepreneurs look to for funding. Both choices have potential benefits and drawbacks that should be carefully considered. Having a clear understanding of each option will allow you to determine which type of funding would work best for your small business.
Here we lay out some key features of each option:
A traditional business loan is often taken out with a bank
or credit union. You apply
, and if you qualify you are approved for a specific loan amount. You will also agree on repayment terms for the balance plus interest. The monthly payment will be the same throughout the life of the loan, unless you and your lender agree to a different structure while discussing the terms. However, you can typically make larger payments toward the loan balance when you’re able, in order to pay off the loan sooner
– much like you can with most mortgage
Keep in mind that a bank will have certain requirements for business loans, and you will often need to present supporting documents
such as a business plan, tax returns, and financial statements during the application process – especially if the loan is for a substantial amount. In some cases, you may be asked to provide a form of collateral
as well. For smaller-dollar loans
, many banks offer a simplified application process with less documentation and faster approval times. Regardless of how much money you’re borrowing, business loans typically offer lower interest rates and more convenient payment terms than a business credit card
is a way to raise money from a group of peers or interested investors. Most crowdfunding campaigns take place online and the funds are raised by many individuals contributing small amounts.
A common misconception about crowdfunding is that it’s “gift money”, and that it doesn’t cost the entrepreneur anything. However, in many cases the recipient of crowdfunding monies must indeed provide the investors with something in return. In some instances, crowdfunding campaigns are rewards-based
. This type of crowdfunding typically requires that the entrepreneur provide the investors with some type of “reward” in exchange for the donation. In most cases this takes the form of a product or service, but sometimes the reward
can be as simple as a handwritten thank you note.
on the other hand, involves providing investors with an ownership share of your business when they donate funds to your crowdfunding campaign. The business financing community typically recommends rewards-based funding for smaller creative projects that appeal to a wide range of people, so you are not giving up ownership of your small business. Equity funding can be a good source of capital for tech or service based start-ups and can also be a good choice for businesses looking to expand
Crowdfunding typically works best when:
• Your business doesn’t qualify for or was denied a traditional bank loan
• You’re unable to launch your business without outside financing
• You don’t require immediate access to the funds
• You have enough resources to create a profitable crowdfunding campaign
Crowdfunding might not be the best option if:
• Your business only serves a small niche market
• You require immediate funding and working capital
• You lack the time and resources necessary to create a strong and compelling crowdfunding campaign
Comparing the Two
The Federal Reserve establishes interest rates that lenders use as guidance when setting loan terms. The exact interest rate you pay may depend on both your personal credit score and your business’s credit score, the amount of money you need to borrow, and other individual factors. In some cases, a bank may also require a borrower to provide a personal guarantee before approving a business loan. Signing a personal guarantee means that you agree to become personally responsible for the debt if your business becomes unable to repay it.
The fees associated with crowdfunding are generally established by whatever platform you choose to execute your crowdfunding campaign on. Most crowdfunding sites charge around 5% in fees, as well as around 3% in credit card processing fees. You can typically set the number of days you want your campaign to run when you set up a crowdfunding campaign on such a site. Some platforms also require you to fully reach your funding goal before they will release the donated funds to you.
Comparing how long it takes to obtain a business loan versus create and execute a crowdfunding campaign can depend on a variety of factors. Some banks may process a loan faster than others based on volume, complexity, staff and more. For crowdfunding, there is no real way to predict how long it will take you to reach your funding goal. Your product or service could drum up a lot of attention and you could raise funds in a week, or interest in your business could be slower and it could take months to reach your goal. In fact, some crowdfunding campaigns never succeed. Unfortunately, there is no clear cut answer on which option is the faster one, although if you are looking to obtain a relatively small amount of financing, a streamlined small-dollar business loan is likely to be quicker for eligible borrowers. Some financial institutions offer instant loan decisions on small-dollar business loans, while others can issue an approval or denial within a couple of days.
Ultimately, the best option for your business comes down to your individual financial situation and preferences. A combination of bank financing and crowdfunding is something to consider as well. Regardless of which funding method you choose to explore for your business, it’s critical to review all of the terms associated with the loan or crowdfunding platform of your choice to understand exactly what you’re agreeing to.
For more information on business loans available from BankFive, or to set up a consultation with a member of our dedicated Business Banking Team to talk through your options, contact us today.