Crowdlending vs. crowdfunding… what’s the difference and why does it matter?

blackboard with the word 'debt' written on it

Crowdfunding has become a hot topic recently and the news that Kickstarter has will officially launch its UK operation at the end of this month means that it will probably stay in the headlines.

Whilst the concept is still relatively new in the UK, Crowdcube (the UK’s biggest crowdfunding website) has helped to raise £4 million for small businesses and Seedrs – the first UK crowdfunder to be regulated by the FSA – has a target to help 400 business raise cash from private investors each year.

There is a genuine surge of interest in alternative finance and for many the idea of ‘owning’ a part of a start-up seems really appealing.  Frequently the chance to support an appealing new business idea is a stronger motivator than the potential financial return.  There is a “community funding” aspect to crowdfunding, as it tends to select the businesses that are perceived to benefit people.

So, that’s crowdfunding; Basically the process by which a business, which is often – but not always – a start-up raises funding in return for some type of equity deal or reward.

But what about crowdlending?

Well, we started using the term crowdlending to describe FundingKnight just after writing this blog post on whether peer to business lending needs a new name? (Which in turn took inspiration from the Lend Academy blog in the US)

The key point about crowdlending is that no equity changes hands.  FundingKnight lenders, or those using other P2P websites to lend to individuals or businesses, simply provide “loans”.

In return, they get a rate of return on their savings which very often beats that available from traditional easy access savings accounts (which right now are struggling to beat inflation!)  They take no share of the company, have no say in how the company is run and have no voting rights or other control over day to day operations.

So, why might an independent business that’s searching for business finance prefer to take a loan – otherwise known as “debt funding” rather than sharing out equity in their company.

Knowing that it’s a topic close to the heart of FundingKnight’s founder and CEO, Graeme Marshall, I asked him to share some of his thought on why debt can sometimes trump equity when it comes to funding a business.

Here’s what he said:

“I often see company’s approaching Angels for equity when they really should be looking for debt.  It was one of the reasons I started FundingKnight.  Why would someone running his own business want to burden himself with outside shareholders whose agenda will almost always be different from that of the owners?”

So that’s the first key difference between crowdlending and crowdfunding:

Crowdlending = Lenders make loans and borrowers pay them back.  No shares change hands, no control of the business is given up.

 

Crowdfunding = Investors provide a cash injection in return for equity in the business or some other reward.  Usually, they will then have a say in the future of the business / how it is run.

Next, comes the question of what happens when investors – or lenders – want their money back?  It’s a reasonable question since, after all, circumstances change for all of us.  Today’s rainy day fund is tomorrow urgent repair fund so having a way to access an investment is pretty fundamental.

When it comes to business finance, Graeme says,

“The key question is “how is the equity going to be turned into cash?”  Ideally, Shareholders need to be aligned on this point.  If not, there needs to be a clearly understood strategy setting out how new shareholders are going to get their cash.  Listed companies whose shares are traded avoid this problem…. Private companies are a minefield!”

So, there’s the second real difference:

Crowdlending = A scheduled plan of regular payments is agreed upfront detailing how a lender will be repaid their capital + interest.

 

Crowdfunding = Every business needs its own strategy for how shareholders can realise their cash… and not all shareholders will agree on the best way to do this!

 

And that’s why Graeme believes that profitable businesses who are expanding should look to borrow first:

“If the cash required for expansion is to turn into profitable sales of goods or services, they should have the means of repaying the loan out of these profitable sales.  It’s also a good discipline on a company, as if they are not generating the cash to service a loan, is the expansion really profitable?

At the end of the day, every business who borrows money needs to know how they will pay it back.  If you can’t see this clearly, but the cash you need it clearly building long term value, you need equity.”

Photo

Business investment is hard to access according to BOE report

damaged ATM

Yesterday saw the release of the latest Bank of England Agents Summary of Business Conditions report.

Unfortunately, the picture remains bleak.

As Christopher Shaw, CEO, alternative finance specialists, Platform Black commented,

“This latest report from the Bank of England confirms once and for all what any company director knows: that (small businesses) just aren’t getting credit and, worse still, are having their overdraft facilities cut or pulled.  In the rare cases where credit is available, it is getting more expensive.”

That’s exactly what we’re hearing, too.  This week, in fact, we were contacted by a potential borrower who had begun searching for a business loan after his bank, of some years, had withdrawn his overdraft facility.

The Bank of England’s report tells a mixed tale.  Whilst large firms, with strong balance sheets, found that “credit was normally available on reasonable terms”; some independent businesses “continued to report that they were unable to obtain credit at any cost.”

Considering the number of promising owner managed businesses, well positioned for growth, that’s a sorry state for business investment in the UK.  As I wrote on this blog last week, there are plenty of sound candidates for small business loans out there; firms that boast impressive turnover and growth of at least 33 per cent in the last three years, but they are currently being let down by the financial sector in general.  To not let these small businesses obtain credit at any cost is to stifle the innovation and growth that Britain needs so badly.

When refused credit from the bank, some small businesses go in search of an online loan whilst others scale back their activities or attempt to finance growth from within.  According to Christopher Shaw, that’s not good news for the broader economy:

“That more companies are starting to finance their growth internally is not necessarily what the Chancellor wants to hear either, as organic growth is slower growth and the economy needs growth now.”

Support for private business investment and peer to peer lending is essential to help plug this funding gap;  banks have done what they can, but more is required – urgently.  That’s why FundingKnight is committed to sharing the message about how peer to peer lending works, and why we’ll campaign for swift regulation of people to business lending too.

Photo used under creative commons license

Mind the gap: 3 reasons the UK needs peer to peer lending

tube train and mind the gap sign on the london underground

Peer to peer lending is a growing part of the alternative finance sector.  Today, we explain why Britain needs people to business lending and the three main reasons to welcome P2P Lending.

Flick through a newspaper these days and it won’t take you long to find a story about how the lack of finance is stifling the growth of British business and potentially slowly down economic recovery.

Whilst small businesses claim that banks have pulled down the lending shutters, the big high street banks complain that there just aren’t enough creditworthy borrowers to go round.

As the debate continues to rage, people are starting to ask why we even need banks at all?

Actually, there are some very good reasons why all of us should be gunning for a healthy, well managed banking system.  As Robert Peston recently argued, without the banks, “we’d all be a lot poorer… they provide about four-fifths of our financing needs”.

That’s not to say, however, that the banks don’t need a helping hand to get Britain back in business.  Three key issues make the current model of small business financing ripe for review:

The Funding Gap – The recent report on the supply of credit for businesses, requested by Vince Cable and prepared by Tim Breedon (ex CEO of Legal & General), revealed that the total stock of lending to UK small businesses has fallen by £151bn since December 2008.

This sharp decline will lead to a gap between what British companies need to borrow and what banks are willing to lend.  Breedon estimates that gap might reach a whopping £191bn within the next 5 years.

Capital regulations – Meanwhile, banks are being encouraged to increase their capital bases.  Rather than lend money out to borrowers, regulations such as Basel III say that banks should hold more cash in reserve, ready to cushion the blow if the worst happens and the banking industry experiences a set of financial shocks similar to those which rocked the world in 2008.

That sounds eminently sensible but already a picture’s emerging of borrowers who need to borrow and banks who need to save.  The losers aren’t just the small businesses that are finding their credit lines restricted, it’s you and me and everyone else who depends on small business growth to fuel economic success.

Choice – Finally, there’s the small issue of choice.  We all know that monopolies are discouraged; that too little competition means that people generally get a poorer deal.

Of course, we’re not saying that business lending in Britain is a monopoly – far from it, as all of the big high street lenders have committed to lending targets under the government’s Project Merlin.

We are concerned, however, by research carried out by the Federation of Small Businesses.  They found that in the US, small businesses are “spoilt for choice when it comes to raising finance”.  There are 15,000 financial institutions in the US competing for business, of which 50% are banks and 50% are credit unions.

Here in the UK, meanwhile, five key banks control 90% of all lending to small and medium sized businesses.

It doesn’t take an expert to realise that if those same five banks are being told to grow their capital reserves a funding gap will emerge.  It’s a funding gap that will only grow if no one steps in to help the banking system service the demand for debt financing, and it’s a funding gap that’s crying out for a healthy, eventually regulated, industry in peer to peer lending.