Business Loan vs. Crowdfunding: Which Is Best for You?

What is a business loan?

A business loan provides companies with borrowed capital. The business can use the borrowed capital to pay expenses it previously couldn’t afford. You can use a business loan to pay employees or contractors, stock inventory, pursue business growth, and purchase office supplies. Business loans are available from traditional banks, online lenders and microlenders. 

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Types of business loans

There are myriad business loan types. We’ll outline some of the most popular.

Business credit cards 

Similar to personal credit cards, business credit cards have a revolving line of credit that’s available to you as long as you make the minimum monthly payments and don’t exceed the credit limit. A business credit card is a popular option for ongoing expenses.

Business line of credit 

A business line of credit is flexible because you pay interest only on the money you use. A line of credit is a valid option for seasonal businesses and short-term financial needs.

Equipment loan 

A business equipment loan is used exclusively for purchasing equipment. The loan term falls in line with the expected life span of the desired equipment. Interest rates are based on how well the equipment holds its value and the financial health of your business.

Invoice factoring

Invoice factoring is a way to get paid more quickly for outstanding customer invoices. It involves selling invoices to a factoring company, which is then responsible for collecting the money when the invoice comes due.

Invoice financing 

If you’d rather not use an invoice factoring company, you can get a cash advance by using your invoices as collateral.

Merchant cash advance 

A merchant cash advance offers fast cash, but it comes at a price. Borrowing costs can rise more than 300%, and you must make payments weekly or via daily withdrawals from your credit and debit card sales.

Microloan 

Nonprofits and mission-based lenders extend microloans to startups, newly established businesses and disadvantaged communities. Microloans are $50,000 or less and can also include consulting or training.

Personal loan

If you have a short business history, personal loans may be your only option. To qualify, you’ll need an excellent personal credit score. However, if you fail to make a payment, it can affect your credit.

SBA loan

Small Business Administration loans, including the popular SBA 7(a) business loans, are guaranteed by the SBA through banks and other financial institutions. However, the SBA application process is extensive, and it can be hard to qualify. Repayment plans on SBA loans can range from seven to 25 years. 

Term loan

Term loans are a common loan type with a predetermined length and interest rate. A term loan will quickly provide you with a lump sum of funding upfront, and it often offers a higher amount than other loan types.

How does a business loan work?

When applying for a business loan, you’ll have to explain to the lender in detail how you will use the loan. Other factors include your business’s size and financial health.

The lender makes the final decision on whether to lend to your company, the amount and the interest rate. You can then approve or deny the loan terms. Depending on the loan terms, the monthly payment obligation will include principal and interest payments.

If you miss a payment on your business loan, you could face consequences such as late fees, penalties, and the loss of any assets you used to secure the loan.

What is crowdfunding?

Crowdfunding is a way to fund a project or business venture through a series of small donations or pledges from multiple individuals or investors. In return, you usually promise to provide one of your products or equity in your business.

You may consider crowdfunding a newer financing source, but it’s actually existed for a long time. Authors and publishers have used it for decades, funding new books via readers who pledge to buy them before they’re released.

Types of crowdfunding

There are four types of crowdfunding. All can help a startup or entrepreneur raise money to grow their business.

1. Donation-based crowdfunding: Donation-based crowdfunding is used mainly by nonprofits to collect financial donations for their causes. Donors do not receive anything in return; they’re supporting causes to which they feel a personal connection.

2. Equity-based crowdfunding: Instead of offering product-based incentives, equity crowdfunding allows investors to receive a financial stake in the company. Although startups can receive a quick financial boost from this method, they could lose majority equity if they don’t handle it correctly. 

3. Debt-based crowdfunding: Companies like Prosper and Lending Club have created debt-based crowdfunding platforms as an alternative to asking family and friends to fund your next business venture. Peer-to-peer (P2P) lending sites can be helpful for businesses unable to get a loan through traditional financial institutions. P2P loans also generally have lower interest rates. However, there is no insurance or government protection for P2P loans, which creates a higher risk for the lender than other crowdfunding methods.

4. Reward-based crowdfunding: Made popular by Kickstarter, reward-based crowdfunding gives incentives to people who pledge money to startup projects and products. For example, a company may provide the donor with one of the final products for a $100 donation. Reward-based crowdfunding can quickly grow a company’s following. However, it’s important that the business delivers on promised rewards to prevent distrust among supporters.

How does crowdfunding work?

Crowdfunding can be especially useful if you’re financing a new project or idea. You’ll validate market interest before sinking money into the project and avoid dreary fundraising work.

This chart should give you a better idea of whether crowdfunding is right for you.   

Pros and cons of bank loans vs. crowdfunding

If you’re debating the merits of business loans vs. crowdfunding, consider the pros and cons of each. Only you will know which option better aligns with your situation and goals. 

Bank loan pros

• There’s no delay in using your funding. The cash is yours once you’ve been approved.
• It offers a chance to improve your credit. Making on-time payments can help build your business credit.
• Ownership of the company is entirely yours. This is in contrast to equity crowdfunding, which requires you to provide investors with equity in your company once a business loan is paid in full.

Bank loan cons

• You may not qualify. Traditional bank loans have strict application and approval requirements. There’s no guarantee you’ll be approved.
• They carry more risk upfront. For example, you could lose the asset you pledged as collateral if you default.

Crowdfunding pros

• You can test the waters. Since crowdfunding success depends on enticing individual investors or investment groups to rally around your idea, it lets you tap into your potential market base before starting your business.
• You can abandon a bad idea. You’ll know there’s little interest before investing additional time and money. If there isn’t enough appeal, your campaign won’t take off, you won’t have access to funds, and you can go back to the drawing board.

Crowdfunding cons

• It’s a lot of work. Crowdfunding requires a lot of upfront effort on your part, and it’s always possible your campaign won’t succeed and your efforts will have been in vain. 
• You’ll need a marketing campaign. To draw in pledges, you’ll need to create a strong, multifaceted marketing plan. 
• You have to do a lot of follow-up. You’ll need to keep up on administrative work, such as correspondence and investor follow-up.

Alternatives to business loans and crowdfunding

While business loans and crowdfunding can generate cash for your company, there are some alternatives worth considering.

Grants

By applying for grants, you could gain access to money awarded by federal, state and local governments that you don’t have to repay. However, business grants are competitive and can take longer to receive than loans.

Venture capital

Venture capitalists are individuals or firms with money earmarked for startups in industries such as tech, medicine and e-commerce. If you seek venture capital, you’ll need a strong business plan and pitch deck.

Jared Proctor contributed to the writing and research in this article.