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 finance: A load of shylocks or simply a sector dying to change

street sign for 'Change Alley'

I read an interesting article this week from Nasir Zubairi, Head of Product Marketing at the Currency Cloud.  His post, Selfish Shylocks, published via the Huffington Post, takes a look at the state of innovation – in general – and the lack of innovation – specifically – in the banking sector.

He makes some really good points, explaining that:

  • Innovation improves the status quo and substantially alters it
  • Innovation focuses on making things better for customers

But he also laments the fact that, in general, UK banks have a. forgotten to share the benefits of innovation with their customers and b. tried to avoid any sort of innovation that promotes anything other than higher profits.

In seeking to explain why the big banks get away with it, Zubairi quotes the stark statistics that prove how remarkably un-elastic customers are when it comes to financial services.  “Out of 64 million bank accounts in the UK”, he tells us that “less than 0.1% have voted with their feet and shifted banking provider in the four years to the end of 2011.  Even then the likelihood is that the switch was to one of the other three big banks.”

The rest of the article rightly applauds some of those at the frontier of new finance.  I agree that new entrants such as Bank Simple, Holvi, Movenbank and The Currency Cloud represent the future of finance but it’s probably also worth asking why now? What needs to change?  What will make people vote with their feet?  Why will things ever be different?

And to answer those questions, I’d add another point to those above describing innovation.

Innovation frequently happens when developments in products or services coincide with some bigger, more important change in the way we collectively live our lives.

The i-pod didn’t create digital music.  The i-phone didn’t invent the smartphone.  Rather they are examples of great product design that came along at just the right moment to capture the public imagination.

It might seem ridiculous to think that something similar could happen to the banking industry, to a sector characterised by complexity and – let’s be honest – boredom.

But, honestly, I really do think something is starting to happen.

Over the summer, I read a book by Harvard professor Youngme Moon called Different. Escaping the Competitive Herd. Standing out in a world where conformity reigns but exceptions rule.

 

Apart from being amused by the very length of that title, I was struck by how relevant the last bit is to what new finance is trying to achieve.

“Standing out in a world where conformity reigns but exceptions rule”

Surely, that sums up where new finance is at right now?

Moon makes some fantastic observations about why the time for change is now, and has already begun.  She notes that many “businesses have forgotten the point of it all – which is to create meaningful and compelling product offerings.”

So can banking – lending or borrowing money – be meaningful?

Yes.

I’ve already explained why I think new finance is more than simply a romantic notion and I wholeheartedly agree with Moon that the global recession has set the wheels of change in motion; “the storm (has) refocused us all in some collective way… even those who were financially secure have begun rethinking their most basic consumption patterns… the age of abundance is over. Not because things are no longer abundant, but because abundance has lost its status as our reigning aspiration.”

So, new finance.  Innovative?  Yes.  Meaningful?  Yes.  Poised to take advantage of being in the right place at the right time?  I hope so.

Creative commons photo source

Bank of Dave… helping the seeds of change to take root in small business funding

minibus on an empty road

If the reading matter mentioned in our last post – Seeds of Change, the latest report into alternative funding for small business from the Centre for the Study of Financial Innovation – didn’t quite measure up to your idea of a good holiday read, here’s a slightly lighter, but no less relevant option…

One of the books I’ll be packing in my suitcase is Bank of Dave: How I Took on the Banks: The Story of One Man’s Heroic Attempt to Take on the Banks.  As its name suggests, it is the companion book to the recent Channel 4 documentary, Bank of Dave, in which we saw self-made Burnley millionaire, Dave Fishwick, do his best to take on the big boys and set up his very own bank.

The programmes certainly captured the public’s imagination.  Twitter was full of #BankofDave, highlighting huge swathes of support for this charismatic character prepared to take on the banks at their own game.

In the end, it’s perhaps that – I mean the public reaction – more than Dave himself that will stick in my mind.

Clearly, Dave has a heart of gold.  He loves Burnley and loves giving something back to the community he grew up in.  For the people it helps, locally, the Bank of Dave is a lifeline whose role cannot be underestimated.

When it comes to a national level, however, it’s less clear how these things can scale. Dave can lend to Tariq – the caterer with a poor credit history – because

  1. He had funds available to underwrite all of the loans made by Bank of Dave
  2. He could look at Tariq in the white’s of the eyes and make a decision about his ability to repay
  3. He had local insight into a local situation and that made it easier for him to “bend the rules”

When it comes to national solutions to the crisis of business finance, controls will inevitably need to be tighter.  After all, no-one wants more lending to people who can’t pay back their loans – that’s what got us into this mess – but if we learn one thing from Bank of Dave, it should be that the public are reading.. and waiting… for change.

The amount of enthusiasm for transparent, no-nonsense banking was immense.  The respect for someone willing to look beyond “the computer says no” credit scores was huge and the desperation for people – and brands – to come along and shake up business funding in the UK was palpable.

It’s time for change.  Dave has started a journey that it’s up to all of us to continue.  Peer to business lending is one way for everyone to get involved in helping their local community.  All it takes is enough borrowers and lenders and soon everyone will have the chance to put something back, while making a decent return.

So, this summer, be inspired by Dave, enjoy learning more about his life and business background in his book… but don’t forget the real message Dave had for us all.

Action is needed.  And action – and progress – begins at home.  It only takes a little step from everyone to change the world, start adding your voice to change today and sign up with FundingKnight for peer to business lending.  It’s a new way to lend and borrow money.

Photo – chosen in homage to Dave and his pimped up minibus tour

New finance is the future…. FundingKnight makes the Huffington Post

Just a short post today to direct your attention to Nasir Zubairi’s latest article on new finance for the Huffington Post.

It’s a well thought out piece, and of course we’re glad to be mentioned in the future of new finance.

Concluding that we can’t wait for our ailing banking system to recover, he writes:

We can do better. The alternatives are already here and innovation in the New Finance sector is progressing at a lightening pace. Entirely new banking models such as Fidor Bank in Germany, Holvi in Finland and Simple and Movenbank in the US will soon migrate to the UK. There are already several young firms focusing on niche elements of financial services to deliver exceptional, transparent and cheaper services to SMEs and consumers. There are firms providing Peer to Peer based access to credit, such as Fundingcircle, Zopa and Fundingknight, other firms providing lower cost access to currency and international trade services, such as Tradeshift, Currencyfair, Transferwise and The Currency Cloud.

Like Currency Cloud, who’ve just won new funding to continue changing the world of forex and international payments for small businesses,we’re ready to start writing the future.

At the end of his post Nasir writes, “New Finance is the future we must embrace”.

Well, we’re ready…. are you?