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.”

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Business loans needs safeguards and restrictions too…. before it’s too late

restricted area sign

The BBC reported yesterday that payday lenders have “agreed to prevent a build-up of unmanageable debts by struggling customers.”

The changes will mean that lenders will “freeze charges and interest for borrowers in difficulty, no later than 60 days after they stop making payments.  Borrowers would also have their charges frozen as soon as they managed to agree an acceptable repayment plan.”

The new measures should be in place by 25th July according to the trade bodies involved.

The move will, no doubt, offer some relief to the increasingly large body of people concerned about the payday loan industry and FundingKnight welcomes it.  The payday lenders involved rightly point out that their new commitment goes beyond statutory regulation and gives new rights to customers.

That didn’t, however, stop Business Minister, Norman Lamb, suggesting people exercise caution:

Payday loans should only ever be used as a short-term financial stop-gap, not as a long-term solution to financial difficulties”

The worry is that, unless positive action is taken to improve the state of funding for business, small businesses will be the next in line to take out a high cost, short term business loan.

We wrote yesterday about the latest BOE figures which reveal that business funding is in dire need of improvement.  The popularity of payday loans only serves to underline the need for fast action and a considered approach to regulation.

FundingKnight strongly believe that more must be done to support funding for UK independents and provide the business investment required for growth and we believe, just as strongly, that the best way to do this is within the safeguard of regulating peer to peer lending.

Action is needed now.  Our economy depends upon it.

Photo used under creative commons license

Business funding: The green shoots of growth are there but business loans must improve

green shoot on black and white background

Business funding – just what is the issue limiting funding for business in the UK?  Do banks not want to lend? Or, do businesses not want to borrow?  That’s the long running debate that’s run and run throughout the British media, but, whatever the case might have been, new research by Experian shows there are plenty of business investment opportunities now.

 

Despite ongoing economic difficulties, British small businesses continue to demonstrate high levels of growth and present ripe opportunities for sound business loans. That is, at least, according to the latest research carried out by Experian for the Business Growth Fund (BGF).

The survey found that there are currently 4,000 mid-sized businesses in the UK who can boast turnovers of between £2.5m and 3100m and who have grown by at least 33 per cent in the last three years.

Investing in one of these 4,000 small businesses via a small business loan would surely represent a sound business investment, as well as helping to get the British economy back on track, but there’s a whole raft of opportunities beyond that.

These 4,000 are merely the independent businesses classified by the report as ‘high growth’. In all, there are 25,533 UK companies with turnovers of £2.5m – £100m and whilst not all of them are positioned for expansion, many are established businesses with a clear route to exploit additional business funding.

Stephen Welton, CEO of BGF, commented:

“This data highlights that despite challenging market conditions, there is a steady base of UK (small businesses) and fast growing UK companies that continue to thrive across the UK and that operate in diverse industry sectors.  It demonstrates the resilience of the group and the underlying quality of UK entrepreneurship.  This is good news for the overall UK economy as these companies play a significant role in job creation and innovation and are a critical part of the economic recovery. “

It is Welton’s job to use the Business Growth Fund to assist some of these companies but it’s becoming increasingly clear that private sector help is required.

The banks are unable to meet the needs of UK businesses and government funding initiatives are, at best, a drop in the ocean.  We were glad to hear that David Cameron has asked the Chancellor what more can be done to support British business and welcome his promise to do “even more” to promote growth.

Perhaps regulating peer to peer lending should feature on the to-do list.  FundingKnight would definitely support that cause.

Photo used under creative commons license