Equity vs. Loan Crowdfunding: Where to Invest?
With over 1,250 crowdfunding platforms worldwide offering up to four models of crowdfunding (donation, reward, loan and equity), the $16.4bn global crowdfunding market is growing faster than ever. In fact, it's estimated to grow to $34bn by the end of this year; outgrowing both venture capital and angel investing.
With this growth the market is becoming increasingly diverse and complex. Such exponential growth has even led to variations within the four crowdfunding models, with each platform offering their own unique set of services.
What's more, crowdfunding is increasingly being used as a catch-all term for alternative finance in general. The term is often confused with peer-to-peer lending (the practice of matching individual borrowers and lenders through online platforms) and in recent months has also been mistakenly absorbed into the broader marketplace lending industry (a term used to describe the many many forms of P2P lending).
Although crowdfunding can involve peer-to-peer transactions, it is more specifically the process of raising funds for a project or venture by a large number of people through an online platform. This can include social projects funded with donations on sites like GoFundMe and artistic or creative projects funded with pledges on Kickstarter, for example.
Crowdfunding also refers to two methods of small business financing: equity crowdfunding and loan (or debt) crowdfunding. These two models are seen as having huge potential for disrupting and democratising finance in the years to come, especially the $300bn early-stage investment market. Both these forms of investment involve different risks and rewards that every investor should consider.
Also, some crowdfunding platforms do more than others to minimise the risks involved. Below is an overview of what investing via equity and loan crowdfunding involves, and tips for building a diversified investment portfolio with both start-ups and more established businesses.
Equity crowdfunding involves investors providing capital to a (typically start-up) business in exchange for a share of ownership in the business, with the expectation of profit if/when the business becomes successful. Investors can expect entitlements to profits and also, to some extent, influence in how the business is run. A main benefit of equity crowdfunding for entrepreneurs is the ability to draw upon the knowledge, expertise and networks of a larger crowd of investors.
There are generally two ways for an investor to earn returns through equity crowdfunding. One is through a dividend paid to shareholders by the business: this is unlikely to happen until the business has grown substantially and is making profits. The second is through growth in the value of your shares in the business. However, only certain crowdfunding platforms - Symbid being one of them - enable investors to "sell" their shares in a business to other investors. In general, the uncertainty of returns makes equity crowdfunding riskier than loan crowdfunding, where investors can expect fixed returns.
If the business fails an equity crowdfunding investor will usually never see a return. What's more, businesses which seek investment through equity crowdfunding are smaller, start-up businesses without a long financial history or proven track record. This increases the risk for the investor, but of course there is a greater upside for those who invest in a successful business at an early stage. Early investors in today's tech giants have seen enormous returns this way. Peter Thiel, for example, saw a return of 800 times on his $500,000 investment in Facebook back in 2005. The key is to find the next Facebook.
Learn more about investing via equity crowdfunding, and the potential risks and rewards, here.
As mentioned above, loan (or debt) crowdfunding is often confused with peer-to-peer (P2P) lending as seen on sites like LendingClub. Depending on your interpretation, loan crowdfunding can include the P2P lending model - loans between private individuals - but should be thought of more as peer-to-business (P2B) lending. But here is where it gets tricky. Many sites offering loan crowdfunding are actually offering a P2P service, despite the borrower using the loan for entrepreneurial and business endeavours.
Loan crowdfunding in the P2B sense involves lending money to help fund a business. Although the criteria can differ across platforms, loan crowdfunding generally requires a good credit history and solid financials. This means businesses are usually larger and more established than those seeking investment via equity crowdfunding, and therefore risks are reduced.
Of course, there is always a risk that the business may fail, in which case the loaned amount may never be repaid - depending on the exact terms of the loan the securities involved. This risk is reflected in the fixed return for investors, which is usually between 5 and 9% per year and is paid alongside loan repayments.
It's worth noting that lending money to a business does not give you any control in how that business is managed, unlike investing via equity crowdfunding.
A Diversified Portfolio
The key to managing the considerable risks involved in crowdfunding is to be flexible in how and where you invest. A diversified portfolio including both forms of crowdfunding - equity and loan - across a number of businesses of different sizes and industries is the only way to reduce risk.
As one of few crowdfunding platforms that offer both loan and equity, we at Symbid highly recommend a diversified investment strategy. Riskier start-up investing should only be considered alongside safer investments in more established business. Aim for a portfolio of at least ten investments in or loans to businesses at different stages of maturity (start-ups, early-stage and established businesses).
Diversification is an essential part of investing – whether you’re a VC firm, angel investor or crowdfunder. That's why it should never be equity versus loan crowdfunding, but both, and within your financial limits.
Are you ready to start building your diversified investment portfolio? Review a range of investment opportunities on the Symbid platform here.
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