Blog Details

Author - Ashima Puri

Crowd-Funding is a way of raising funds for a business or startup online. All one needs to do is convince the public to believe in his or her idea. Once they believe it, they will grant or donate funds for the project. A large number of people who fund a venture using the internet as a medium are known as investors or donors. Though fundraising and crowd-funding are under debate regarding their efficiency, the power of the social media has made the latter more successful than traditional fundraisers.

Among all other types of crowd-funding, debt-based crowd-funding is one of the most promising ways to raise funds. This method of debt crowd-funding for business is the best way to raise money from multiple investors at a time online. Thus the debt-based crowd-funding platforms are those online places where every individual investor or donor chips in their spare cash and announces the returns they are willing to receive at the end. It's the job of the owner or founder of the venture, that is being funded to make everyone happy based on the initial bids collected from the public.

From the perspective of a borrower, debt-based crowd-funding platforms are instruments in the online mode, where companies stipulate the requirements of the loans, regarding the amount needed and goal of the business. In the language of a layman, debt crowd-funding platforms enable entities to disclose the vital information on a peer-to-peer basis. This method resembles and has gone to replace conventional financing with a loan offered by a bank.

How Does It Work?

Suitable for most established ventures and recently a lot of startups, debt crowd-funding requires companies to detail their needs regarding the loan sought in a pitch and then submit their financials to a peer-to-peer lending platform or a crowd-funding platform. The platform, as part of its due diligence and credit checks, will decide and define the terms of the loans. Depending upon the amount targeted, such company may be required to give some security in the form of a business asset or a personal guarantee to ensure returns.

The platform then, promotes the business venture to potential investors through its website and other online channels, thereby opening up the lending process. The site separately holds all the money raised by this way until the full amount is successfully raised. Though it varies at large, the loan repayments may begin in a month or two from the date of receipt of finances by the company. The crowd-funding sites or platforms provide a separate dashboard for the investors to monitor the status of the investments made by them.

While the debt-based crowd-funding method is secure and hassle-free due to the usage of the internet as an instrument to source funds and saves a lot of time that would have been spent waiting for loan approval from the big financial players in the market, this method is not devoid of drawbacks. Any investment brings along its risks. For an investor, his or her money is always at risk; therefore, they have to be careful before investing. In case a company fails, and is unable to make repayments, lenders or investors may lose some or all of their investments. This is also termed as the default risk. Such defaults may lead to the loss of a considerable portion of the principal invested.

Subject to volatile market conditions, if there are extreme changes in the purchasing power of an economy owing to inflation, for instance, the money invested has lower chances of generating enough cash flow in the future. A potential escalation in the interest rates in the market may bring about significant changes in the value of the investments. Such a difference in the absolute level of interest rates is a big risk for the value of fixed-income debt investment.

Unlike its equity-based counterpart in the case of the debt crowd-funding, a slice of the company is not promised to the donor or lender or investor. Even though raising funds through debt-based setting is easy but it, sooner or later, has to be paid off. There is no alternative option to escape debts in the future. Be it prospering or stagnant; a business has to pay back the debts with interest within the deadlines.

It is advisable for the investors or lenders to do their due diligence and understand the specific sides involved in this process of raising funds.

The help of a professional or expert can be sought both by the giving and receiving parties to ensure secure and smooth functioning of the crowd-funding process. The critical point here is never to invest more than what one can afford to lose. Then only investments of these types will have lower risks and higher returns. Despite the risks involved, debt-based crowd-funding is still a great investment option.