One of the most common and pressing issues for small business owners is funding. Whether you’re a new entrepreneur or the owner of a well-established venture looking to expand, you’re just as likely to worry about having enough capital on hand.
There are many routes a business owner can take to avoid the fate of other businesses that folded due to cash flow issues, which is often cited as the number one reason why small businesses fail. Two of the most popular options are taking out a business loan and turning to crowdfunding.
These two concepts are fundamentally similar. They both involve raising capital from an outside party, and both may require you to pay back contributors in excess of amount received.
Each form of raising capital comes with its own set of pros, cons, and responsibilities. Whether one is a better choice for your business than the other will depend on your particular financial situation.
Let’s review both business loans and crowdfunding to see which one makes more sense for you right now:
What are business loans?
A business loan, also known as a term loan, is when a lender extends a chunk of money to a business owner, which will be repaid in regular installments plus interest.
Small businesses typically find it more difficult to obtain affordable business loans than large corporations do, especially from banks. In fact, the SBA loan program exists specifically to guarantee bank loans for small businesses, in order to help them find financing at affordable rates.
Online lenders have proliferated in recent years, and many of them can extend financing to small businesses in as little as one day, albeit at higher interest rates than what they would receive from a bank.
What is crowdfunding?
Crowdfunding is when you finance a business or new project by raising money through contributions from a collective of people. Many popular crowdfunding platforms rely on small contributions from a large population to help launch a new business or product. Other crowdfunding platforms help finance larger financial needs for established or growing businesses. There are a few different kinds of crowdfunding but the most common is reward-based crowdfunding, when a business owner or entrepreneur might deliver small rewards in exchange for a contribution.
Just like online lending, crowdfunding has exploded in recent years; there are now hundreds of crowdfunding platforms that cater to different types of projects, different styles of fundraising (equity-, donation-, or rewards-based options) and different stipulations and rules. For example, some platforms will only let you take money from contributors if you reach your stated financial goal, while others will let partially funded projects receive funds as well.
Typically, to persuade users and strangers to contribute to your crowd fundraiser, you’ll need to create a compelling pitch, which could include photos, videos, testimonials, research decks, and other evidence that your concept or product will be a useful, legitimate success.
When is a business loan right for me?
Business owners need to be very careful when considering a business loan. There is always a risk when you agree to take on debt, even if you’ve run the numbers and decided that the payoff is worth the potential issues.
That being said, a business loan is a good bet if you and your business can say the following:
- Your business financials are strong: The most important factors that lenders consider when you apply for a loan are your credit scores, your time in business, and your annual revenue. If all of these are strong, you are more likely to receive offers for loans at affordable interest rates.
- You need a large chunk of money: Banks and other lenders don’t typically lend to businesses looking for less than $50,000. In fact, the average size of all business loans is $663,000, according to recent data. You’re not likely to hit that number with a crowdfunding effort.
- Your funding needs aren’t immediate, or, conversely, you need funds right away: This is a seeming contradiction, but it’s true: Loans from banks or through the SBA loan program will likely require an application process that takes months. Online lenders can sometimes supply you with funds the same business day at high interest rates. The middle ground—30-60 days—is where crowdfunding is a better fit.
Think of a business loan as a springboard to greater success, rather than a lifeboat. If your business is struggling, a loan may only help keep you afloat for a limited time; if you’re profitable and healthy, access to capital will help open even more doors for your business.
When is crowdfunding right for me?
Although a relatively recent phenomenon, crowdfunding is expected to grow to a $300 billion industry by 2025. For certain businesses and situations, it may be a perfect fit. For example:
- You have a relatively new business: Startups have more limited options when it comes to affordable bank loans. Crowdfunding may be an easier and less expensive way to obtain funding without going through a bank.
- You have smaller capital needs: If you’re looking for less than $50,000 - $100,000, which many banks enforce as the minimum borrowing amount, crowdfunding can provide funding that better fits your needs. The average amount of a successful crowdfunding campaign is about $7,000. Although some campaigns for big-dollar amounts do succeed, they are the exception, not the rule. There are also newer platforms and options that cater to higher-dollar campaigns, in case your needs grow or you’re seeking a large infusion of capital right away.
- You can offer valuable (but not costly) rewards: Be sure you can put together a list of potential rewards that won’t, in turn, take away from your crowdfunding earnings. The more non-monetary awards you offer, such as social media shoutouts and item preorders, the better.
- You’re open to different forms of investment: Business loans are debt-funding, pure and simple. Crowdfunding can be equity-based (you sell a small piece of your business in exchange for capital), debt-based (you repay investors, plus interest), or donation- or rewards-based.
- You are prepared to try again: Less than a third of all crowdfunding efforts successfully meet their goal. You may need to rework your pitch multiple times until you find paydirt—and there’s no guarantee you will.
Both traditional financing and crowdfunding are appealing options to successful and promising businesses. You may find that a combination of both options is your best path forward or that neither makes sense for you at this time and you’ll continue to grow organically.
Either way, it’s important to recognize that both routes will take time and energy as you prepare your application and/or your pitch. The payoff, however—in the form of low-cost capital that can help catapult you to the next level, or get your excellent new idea off the ground—is worth it.
Bio: Eric Goldschein is an editor and writer at Fundera, a marketplace for small business financial solutions such as business loans. He covers entrepreneurship, small business trends, finance, and marketing.