Alternative lending companies like Lendio have experienced a big upswing in recent years as traditional debt capital sources have put the squeeze on small business. This large and growing secondary market has emerged as a dominant force and, in many cases, a direct competitor to the more traditional sources of debt financing. But it doesn’t mean the creativity of small business finance has reached a proverbial dead-end. In fact, alternative lenders may only be scratching the surface of their financing potential as the full repercussions of the JOBS Act finally begin to trickle-down on non-accredited investors.
Today’s typical crowd funders receive very little in return for the money spent on a product or service. In fact, most represent the 99% of folks whose liquid wealth is below $1 million and who make less than $200K a year. In other words, they’re unqualified and non-accredited, taking them out of some of the best equity and debt-based crowdfunding deals. When the JOBS Act becomes a complete reality, any individual investors will have the opportunity to purchase equity and debt in privately-held businesses. This represents another massive shift in the way businesses attract capital and is likely to shake-up traditional lending yet again.
Equity vs. Debt Crowdfunding
When companies seek financing for growth or working capital needs, they’ll often play out various scenarios for different financing schemes, weighing the pros and cons of debt vs. equity. The same holds true for any business seeking to raise capital with crowdfunding–they’ll need to weigh the options of choosing equity vs. debt financing.
With equity, no immediate or regular payment plan is required. The company simply gives up a small portion of ownership in the business for some up-front capital. The investor may receive his/her return in the form of dividends, a merger or acquisition or other buyout scenario. In many cases, the investor may not receive a return on investment at all. If the business is a high-growth company with a large potential upside, then giving up some initial equity may be the wrong move entirely.
With debt crowdfunding the shareholders receive up-front cash on typical (and hopefully favorable) payment terms over a period of several years. While no equity is diluted or sacrificed for the loaned capital, the company’s shareholders do inherit more risk as debtholders now trump equity-holders in the pecking order in the event of company insolvency. But, if shareholders are confident in the ability to maintain debt payments and if the business is expected to have serious upside potential, debt can be a viable alternative to equity finance. We continue to see this decision played out with the clients of Lendio and other alternative lenders.
Debt Crowdfunding = Choice
The idea of crowdfunding one’s personal debt is not new. Companies like Prosper and Lending Club have been providing peer-to-peer lending for many years, giving investors and individuals a way to bridge a gap in personal finance often left void by banks and other lenders. Other personal crowdfunding sites act as donation portals where personal causes are shared on Facebook and Twitter soliciting the friendly assistance from friends, family and others in one’s network in the finance of some worthy cause goal or personal need. This type of finance will be a natural extension in the business world.
Crowdfunding debt for small business complicates things a bit. Securitized notes, like those sold in a crowdfunded debt scenario require SEC registration. Hence, the JOBS Act will be a game-changing tool for small business seeking debt financing from a crowd of friends, family, customers, partners and others within the business or personal network. Some companies in the debt crowdfunding space have already announced pre-launch prior to the full JOBS Act implementation, to much fanfare.
The real benefit of most of the debt crowdfunding portals that have already launched is that they allow the business owner or entrepreneur to pick the APR on the loan and then solicit the assistance for funding the loan amount needed from within their network. While the writing is not yet on the wall, this form of debt financing puts more control in the hands of the small business owner and ultimately provides them a better deal on their rate and terms if they are able to successfully fund their debt. Debt crowdfunding is a form of capital democratization where more choice is given to both the customer and the investor, providing a win-win for all involved.
It is certainly doubtful that crowdfunding business debt obligations will completely trump current traditional and alternative sources, but it likely will stir fierce competition among all lenders in their efforts to woo and acquire more customers.