A decade ago, if your small business needed funding you would have to call banks to know your loan options or get your loan approved. If you weren’t successful at getting a loan, you would have had to work towards impressing investors. Sounds exhausting, isn’t it? 

Fast-forward to the 2020s and you have progressive technologies with exciting business financing options like crowdfunding and peer-to-peer funding. So, entrepreneurs can skip the traditional financing methods and opt for these alternative methods of funding

But, what’s the difference between crowdfunding and P2P funding? 

The two concepts are often lumped together by people. They seem similar because they involve individuals coming together to offer financial support for a project. However, both these fundraising methods have several distinctions. 

If you plan to raise capital for your business, it’s important to know the difference. Read on to learn more.

Crowdfunding 

Crowdfunding is derived by combining two terms – crowd and funding. So, the investors (sponsors or donors) combine forces to support a business. 

How Crowdfunding Works? 

Thanks to the plethora of crowdfunding platforms available today, getting investors to support a project is easy. All the entrepreneur needs to do is offer their project or idea for review. If approved, the fundraising process begins and the venture receives the funding in its beneficiary bank account.

Crowdfunding comes in different shapes. 

  • Equity Crowdfunding – The investor is naturally looking to obtain a financial benefit like a stake in the company for the capital. If the venture turns out to be successful, the investor’s shares hold more value. 
  • Reward-Based Crowdfunding – Platforms like Kickstarter and Indiegogo deal in reward-based donations where sponsors, donors, or patrons volunteer to support a project for a bonus like a reward, such as a free product or service.
  • Debt-Based Crowdfunding – This is somewhat similar to P2P lending. The project owner borrows money from individuals and is required to repay within a specified time. 
  • Donation-Based Crowdfunding – As the name suggests, the donor is supporting the project because they like the idea, not because they expect returns. This type of funding is mostly for a charitable or social cause. 
  • Royalty-Based Crowdfunding – In this, the supporter is offered a percentage of the revenue collected from the venture once it starts making a profit. 

Benefits of Crowdfunding 

  • Crowdfunding allows you to get close to the market and validate your ideas. It also builds a market for your product even before it’s out there.
  • The noise around your idea helps in creating product momentum.
  • It offers entrepreneurs and SME owners access to a wide pool of funding.

Risks of Crowdfunding

  • It doesn’t find investors for you. So, you need to work hard, pitching ideas and convincing investors to support your project.
  • Crowdfunding is often affected by scams.

Peer-to-Peer Lending (P2P or Social Funding)

P2P lending allows business owners to procure business capital directly from lenders without the involvement of a financial institution. P2P fundraising has the power to reach a larger audience of supporters than crowdfunding.

P2P lending platforms bring together potential investors and businesses looking for a loan. The investors are assured of their investment being repaid along with interest over a specified period.

How Does P2P Lending Work?

As mentioned earlier, a P2P lending website connects entrepreneurs and business owners seeking a loan with willing investors. These sites charge an interest rate based on your past credit scores and financial history.

Investors can select the type of business or project they want to finance, like mortgage loans, car loans, loans for short-term needs, or personal loans among others. They earn money through the interest the borrower pays. The borrower is charged with the interest as well as the P2P platform fees

Benefits of P2P Lending

  • P2P lending is an online process. So, forget the tedious paperwork and hours of waiting like in the traditional financing options.
  • It doesn’t require borrowers to pay penalties in case they wish to pay off a loan in advance.
  • No collateral is needed for the loan.
  • Online P2P portals are transparent. So, business owners get a clear update on the progress of the fundraising and who has contributed.
  • P2P lending sites find investors, making the process of borrowing capital easy.

Risks in P2P Lending

  • P2P lending may prove to be risky for lenders if the borrower doesn’t pay back. However, the P2P platforms help investors deal with this risk. For instance, P2P loan marketplaces like Swaper offer a Buyback on loans that are completely defaulted and refund the loss.
  • Online P2P platforms only prefer creditworthy borrowers. Plus, if for some reason you aren’t able to fulfill your duties as a borrower, your reputation is affected.

The Way Forward: Choosing between Crowdfunding and P2P Lending!

Crowdfunding and P2P lending are great methods entrepreneurs can use to build capital for their ventures. However, choosing the right fundraiser isn’t easy.

Remember –

  • Crowdfunding has more risks than P2P lending as it requires investors to make well-informed decisions. It offers different financial schemes like rewards or stakes.
  • P2P lending is less risky as it offers more explicit promises on returns. It compels borrowers to fulfill their obligations earnestly.

Consider which model you are gravitating towards. What’s your business niche? What’s the desired role of your investors? Finally, think about how you can prove your business concept and decide on the most suitable option.

Posted by Outside Contributor

From time to time, we are glad to feature outside authors who contribute to BizzMarkBlog with their insights and experience. This is one of those features.