What is Debt Crowdfunding?
Co-Founder & CEO
Debt Crowdfunding overview
Debt crowdfunding is a way for businesses to borrow money from many individuals through a crowdfunding platform. It is primarily used by later-stage startups and Small and Midsize Enterprises (SMEs) with at least a couple of years of financial history. Much like a bank, investors lend money to the business, expecting to receive it back with interest.
Debt crowdfunding is considered a lower-risk investment when compared to other crowdfunding investment opportunities. The returns are usually predetermined, following the agreed-upon repayment schedule. Therefore, you will know beforehand the exact payments you will receive unless the business goes bankrupt. Even if it does, debt investors (creditors or lenders) are the highest in seniority, meaning that they are the first ones to claim back their money from what is left over from the business.
How Debt Crowdfunding Works
There are three parties involved in every debt crowdfunding transaction. See below who those parties are and what each one does.
- Project Owner: As the host of the campaign, the project owner is the entity seeking to borrow capital from investors. Once their campaign is live, they are responsible for investors’ queries about the company and transferring the securities to investors once the campaign is successfully completed. They must also carry out the investment objectives stated in the Key Investor Information Sheet (KIIS) on the campaign’s page.
- Investors: As backers of the campaign, investors lend their capital to the project owner, expecting to receive it back with interest. Before investing, they can find all the information they need on the campaign’s page, as well as ask more questions directly to the project owner. After investing, they receive the appropriate documents regarding their ownership of debt securities, including repayment schedule and promised interest rate.
- Platform: As a mediator, the platform is where project owners and investors come together. The platform acts as a neutral intermediary, facilitating the exchange of funds and debt ownership between project owners and investors. It is responsible for ensuring the quality and authenticity of investment opportunities and advertising available deals to the crowd. It also ensures that project owners’ and investors’ identities are verified, and all regulatory standards are followed. Lastly, the platform is also responsible for collecting the funds from investors and safekeeping them with a reputable financial institution.
The Pros and Cons of Debt Crowdfunding
Like investing in any other asset class, investing in debt crowdfunding comes with its own advantages and disadvantages. Before investing, you should thoroughly study all available resources on the campaign’s page, including potential benefits and risks.
The Benefits of Debt Crowdfunding
- Promises higher interest rates than what you would get from banks or savings accounts.
- Receive regular capital and interest repayments with minimal investment.
- Offers investors the opportunity to invest in businesses or ideas they resonate with and be part of their journey.
- Relatively a low-risk investment, as the loan is shared among several investors and is usually backed by business assets.
- Easier for businesses to secure funding, fostering growth in the local economy.
- Allows businesses to raise capital without giving up ownership.
The Disadvantages of Debt Crowdfunding
- Does not offer additional returns if the business does exceptionally well.
- Exposed to inflation risk, as debt raised through crowdfunding is usually not inflation-protected.
- Might lose seniority ranking if the business raises additional, more senior debt.
Who should invest in Debt Crowdfunding?
As is the case with the other investment opportunities on our platform, anyone can invest in debt crowdfunding. Minimum and maximum investments may vary by campaign, but in most cases, you can invest from as little as €100! Debt crowdfunding is ideal for people who have spare money sitting in savings accounts. They can invest a portion of that and earn a decent interest instead of ~0%, which is the current deposit rate. It is considered a relatively low-risk investment; however, it does have its own risks.
Debt crowdfunding gives individuals the opportunity to invest in securities offering higher interest rates than banks and savings accounts. It is a relatively low-risk investment, as loans are usually backed by business assets.
Additionally, it offers investors the opportunity to invest in socially impactful businesses without taking the additional risk of equity ownership. You can start earning interest on your hard-earned cash by investing from as little as €100!
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