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The word crowdfunding gained importance in the business world of late, especially after the triumph of the first African-American president of the USA, Barack Obama who became the first presidential candidate to successfully raise funds for his election campaign via the internet. Crowdfunding is a way of funding big and small ventures by raising small amounts of money from a large number of people through the internet.

Debt-based crowdfunding is one of the four ways of crowdfunding through which a company or a startup attracts investors and raises funds. Lucrative for big industries like property and housing, this type of crowdfunding runs low at risks for both investors and the company alike.

Picture this, you decide to establish a business to sell marvel based merchandise. Your parents and friends are supportive of this idea and agree to loan money to help their dear friend. You decide that 10 percent interest will be given on the principle amount which will be repaid after 3 years. As security, you deposit your car and housing papers. Your business does well and after three years everyone enjoys the taste of profit.

Money, if lent by a bank is called loaning; if lent by multiple investors in small amounts through the internet is called debt-based crowdfunding.

Companies look for investors for their projects online who loan out money with a fixed repayment term and specified interest rates during the term of the loan. There are two types of instruments the investors can use to enter the debt crowdfunding agreement- entering into shares or simply loaning out money.

Each investor submits the money they would like to invest and the interest rates they would want on their returns. Once enough investors are garnered, an average is calculated of the bids submitted, to decide upon the interest rate. It is similar to taking loans from the bank with the exception that smaller amounts are borrowed from multiple people and the interest rates are low. Fundraisers are reached through the internet, cutting short the otherwise administrative costs involved. This benefits the borrower as the loan is agreed upon faster without much hustle and the interest rates are lower.

Debt-based crowdfunding is the most suitable method for small companies to garner funds who otherwise, might not get loans from the bank. A major advantage that debt crowdfunding has over its similar counterpart, equity, is that the company ownership remains in the hands of the founders. Unlike equity, part of the ownership is not given to the investors for their investment. Instead, they receive shares and dividends on profit shares. So investors get a small part of the profit every year and the owners enjoy complete ownership of the company. It’s a win-win for all!

Another advantage for investors is the certainty of repayment. The company has to deposit assets like land, factory, instruments et cetera as security. In case the venture fails, investors run at low risk of losing their money for they can recover it through securities deposits.

Nothing is perfect. And what seems perfect is not real. The most obvious disadvantage of debt-based crowdfunding is repayment of the loan with interest. Regardless of whether the business is successful or not the borrowed money had to be returned with interest rates within a fixed period of time.

Debt-based crowdfunding will be more beneficial to those ventures which are already established or have assets and enough cashflow to make repayments. For newly established projects, reward or equity-based crowdfunding would be a better option. Whatever method one chooses, it is imperative to consider the pros and cons before employing it.