Crowdfunding or business loans: Which option is right for you?

Business loans and crowdfunding are both popular options among start-up business owners. If you are looking to launch a new business soon, you should be giving careful consideration to how you will finance it. Both business loans and crowdfunding have benefits and potential drawbacks. Deciding which one is right for your new small business comes down to evaluating the similarities and differences and then determining which type of financing would be most beneficial.

Basic Requirements of Business Loans and Crowdfunding

When you take out a traditional business loan with a bank or credit union, you repay the balance plus interest over time. The monthly payment is always the same unless your lender has structured it differently. Most lenders do not charge an early payoff fee.

Keep in mind that qualifying for a bank business loan can be challenging due to strict criteria. You should be prepared to provide significant documentation and potentially a form of collateral as well. A business loan from a bank or credit union offers lower interest rates and more convenient payment terms than you would find with most credit cards.

Crowdfunding is a way to raise money from a group of your peers or interested investors. Most crowdfunding campaigns take place online. A common misconception about crowdfunding is that it is gift money that comes at no cost to the organizer. If you choose to establish a crowdfunding campaign, you can choose rewards-based funding or equity funding.

With a rewards-based crowdfunding campaign, you offer prizes to family, friends, and business contacts in exchange for a donation to your business financing. Equity funding involves providing investors with an ownership share of your business when they donate to your crowdfunding account.

The business financing community typically recommends rewards-based funding for smaller creative projects that appeal to a wide range of people. Equity funding is an excellent source of capital for newly-launched businesses and companies looking to expand.

Crowdfunding typically works best in these types of scenarios:

• Your business does not qualify for a traditional bank loan
• You are unable to launch your business without outside financing
• You do not require immediate access to the funds
• You have enough resources to create a profitable campaign

You also need to consider when crowdfunding is not the best choice, such as:

• Your business offering serves a small niche market
• You require immediate funding and working capital
• You lack the time necessary to create a strong and compelling campaign
• Your new or expanding business does not have a marketing team available

Comparing Fees and the Application Process

The Federal Reserve establishes interest rates that lenders use as guidance when setting loan terms. The exact interest rate you pay depends on your personal and business credit scores, the amount of money you need to borrow, and other individual factors.

Ever since the economic recession that ran from approximately 2008 to 2010, many banks require borrowers to provide a personal guarantee before approving business loans. Signing a personal guarantee means that you promise to repay the loan with personal or business resources. The personal guarantee stands regardless of your profitability or whether you close the business.

You should be prepared to provide a business plan, tax returns, several financial statements, and a down payment when you obtain a bank loan. Lenders also prefer to see at least two years of business history. You can expect to wait one to three months to hear whether the lender has approved or denied your loan request.

The fees associated with crowdfunding are those established by the platform for creating a campaign. They typically range from five to 15 percent. Crowdfunding platforms charge a payment processing fee as well to cover the cost of accepting credit cards. The usual range is three to six percent.

You can set the number of days you want the campaign to run when you opt for crowdfunding. Be sure to research crowdfunding platforms carefully since some require you to reach your financial goal before releasing your funds. In terms of time from the start of the campaign to receiving your money, crowdfunding is generally the faster option over obtaining a business loan.

Speak to a Business Advisor if You Struggle to Choose the Best Option

You should have a good idea of which direction to take after you have weighed the pros and cons of obtaining a business loan against opening a crowdfunding account. If you still do not have a clear idea, consider hiring a business coach or advisor to gain an outside perspective of which business financing option makes the most sense. You could even discover that neither of these choices will work. While frustrating, your business coach or advisor is there to help you find an even better solution.