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Crowdfunding is a well known but often misunderstood form of finance. UK crowdfunding includes lots of different crowdfunding sites, some of which specialise in crowdfunding for business — equity crowdfunding, business loans (in the form of peer-to-peer lending) and property crowdfunding.

What is crowdfunding?

It's difficult to give a straightforward crowdfunding definition because there are so many different types — in its most simple terms, crowdfunding is a method of raising money by sourcing small amounts from a large number of individuals (the ‘crowd’), rather than getting the full amount from one lender or investor.

This democratic way of raising cash has proved popular with a wide variety of businesses, and can be used in a wide range of scenarios such as:

  • selling equity in a business
  • borrowing money for a business
  • selling preorders of a new product
  • raising money for a charitable cause

With this in mind, let's look at the three main categories within crowdfunding:

Donation and reward

This is the kind of crowdfunding that many people associate with charities and the arts, where people donate because they believe in the cause. An obvious example is charity fundraising — people give money and get nothing in return because they’re happy to support the organisation.

Many crowdfunding websites offer a variation of this concept where a reward is offered for donating. For example, a business offering pre-orders for an innovative product months before it’s available. Donation and reward crowdfunding works well for some businesses, but is perhaps less relevant for others, depending on their industry.

Peer-to-peer lending

With peer-to-peer lending (also known as P2P) the business borrows money from a collection of individual lenders, and pays it back with interest. These types of crowdfunding sites act as the gatekeepers, so while they're not directly lending money to the business, they still have an underwriting team to assess risk for the individuals lending via the platform. For this reason, peer-to-peer lending is similar to a traditional unsecured business loan in terms of eligibility.

There are some P2P lending platforms that allow individual lenders to ‘bid’ for the project, which in theory means the business might get a better interest rate than if they went direct to a single provider. It’s also beneficial for the lenders, because they have an alternative to more traditional investment channels, and may make a higher return.

Equity crowdfunding

Similar to peer-to-peer lending, but investors take equity (or shares) in the business, rather than repayments for a loan. This means they have a higher risk and no defined timeframe for getting their money back, but the chance of a better return if the company is a success. It also means they’re investing in the future of a business, rather than simply providing a short- or medium-term loan.

Equity crowdfunding can be a good option for businesses that want to raise money for growth, but aren't eligible for a loan, or don’t want to take the risk of agreeing to a repayments schedule. Other firms won’t want to give up equity in their company, and will prefer to raise money using debt instead.

Property crowdfunding

Property crowdfunding takes the concept of peer-to-peer finance and combines it with property investment. Some variants allow individuals to invest in small shares of many different buy-to-let properties, while others are aimed at the commercial property finance market.

The latter are essentially peer-to-peer platforms that specialise in property development finance. In other words, property businesses that want to borrow money for a specific project can raise the money via individuals who want to lend to property firms. One other key difference is that property crowdfunding is normally secured, which makes sense as the sums of money involved tend to be higher.

Crowdfunding vs. peer-to-peer lending

It might seem like there are dozens of differences between the various crowdfunding platforms. But comparing them is actually quite straightforward:

Crowdfunding is a catch-all term for raising money via 'the crowd' — whether for a business, a charity, or a private individual.

Equity crowdfunding is the name for selling shares of your company to 'the crowd' — there’s no money to pay back, but they’ll be entitled to a share of future profits and you’ll sacrifice some control.

Peer-to-peer lending and marketplace lending are the names for loans which are lent by 'the crowd' — that means you’ll have a schedule of repayments to stick to. With these finance types, you’re effectively getting a business loan from a number of parties rather than one lender.

Should I choose equity crowdfunding or peer-to-peer lending?

The simple way to compare the two is ask yourself: do I want long-term investment or shorter-term funding? Selling equity means you don’t have a timeframe to pay back a loan, in return for sacrificing some control and some future profits. This can be an appealing option for new-start companies, but it means you’ll have to make your business attractive to potential investors.

Peer-to-peer lending, on the other hand, may be easier to secure than a traditional business loan, but the disadvantages include potentially higher rates. Bear in mind that the appeal of P2P for investors is to get a higher rate of return than is currently available in forms of personal saving, like ISAs or bonds — so you might get a better deal elsewhere.

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