When it comes to funding a startup, there are a lot of different options out there. You can go the more traditional route and take out a loan, or you can try a more innovative method, like crowdfunding. Each has its own set of benefits and drawbacks, which you should be aware of before making the final decision on which method is best for you.
Almost everybody is familiar with the way loans work. You determine exactly how much you need, make sure your credit score is high enough, then find a lender and go through the application process. This usually requires many different documents, like a background check, a credit report, a business plan, an outline of why you need the money and how you’re going to use it, financial statements, etc.
After you’ve submitted all of the necessary documentation, you wait to hear back about whether or not you were approved. If approved, you’ll get the funding you’ve requested and make monthly payments to pay back the loan. Although there are a few different types of loans you can apply for, most of them work similarly.
● You can typically get a good interest rate compared to other financing options. Other financing options, like a business credit card, may have high-interest rates, which can make your monthly payments go up and exceed what you’re able to afford. With a loan, you can typically get a good interest rate and keep your monthly payments within budget.
● Interest payments are usually tax deductible. Although nobody loves paying interest, the fact it can be tax deductible makes it a little less painful. You may find at the end of the year that you get a hefty refund you can put back into your business.
● Lenders are not entitled to your money and cannot tell you how to run your business. Although you’ll have to show them a business plan, lenders can’t tell you how you should run your business, and they aren’t entitled to any payments other than the loan (with interest). That means your business is yours and you maintain control.
● You must meet the strict criteria set by lenders. As mentioned, the application process requires a lot and can be long and frustrating. You have to make sure you meet all of the criteria set by lenders; otherwise, you won’t qualify.
● You may have to put up collateral. Not all loans require collateral, but many do, which means you’ll have to put up your car, house, or something else of value to help guarantee the loan. If you can’t make the payments, then your collateral becomes the property of the lender.
● A loan is a liability until it is paid off. Until it’s all paid for and done, a loan counts against you. That can negatively affect your credit and could cause you some issues in certain cases.
How it Works: Crowdfunding is a lot of different, small donations or pledges from many different individuals and investors. A lot of crowdfunding platforms are available online, some of which are focused on niche products and businesses, making it easy to find individuals and investors who are interested in your business concept.
Rather than submitting tons of documents to a lender, when crowdfunding you typically create a profile and upload marketing materials such as a walk-through video of what your product or business is and how it works, a business plan or whitepaper, and any other supporting documents and materials you might want to offer prospective investors.
In exchange for investments and pledges, you will typically provide them with a promise of your product once it launches or a certain amount of equity in your company. Rather than paying back a loan to someone who gave you money, your investors and pledges will give you money in advance in exchange for a part of your company.
● You don’t have to repay the money you raise. Unlike a loan, crowdfunding is investments that don’t have to be paid back in cash. They are paid back in product or sometimes equity.
● You raise money and awareness. Through crowdfunding, not only are you raising money to get your business off the ground, you’re marketing and raising awareness about your brand and your product. Social media is big on crowdfunding, and that’s one of the best ways to spread the word and gain recognition before you even launch.
● You can validate your product or business idea. Crowdfunding is validation your idea is something consumers want. If you get the backing you’re asking for, you’ll know you already have market.
● You will have to follow the rules and pay the fees of the platform you choose. All crowdfunding platforms have rules and fees you’ll be subject to when raising money. You may not be able to post the materials you originally planned on and you’ll have to raise enough to cover your needs and the fees associated with the platform.
● You may have to give up equity in your company. While not all crowdfunding campaigns offer equity in exchange for investments, if that’s the route you choose to go, you’ll have to give up equity, and therefore some control in your company when you finally launch. This means you may not have the final say in all of the decisions anymore.
● You may have to deal with copycats. Although it’s unethical to copy someone else’s business, and illegal if they’ve gone through the necessary steps to protect themselves, people still do it. When you launch a crowdfunding campaign, if you’ve got a great idea, copycats will steal your work. It can sometimes be very difficult and costly to combat them.
Although we’ve only covered a few of the different benefits and drawbacks to both taking out a loan and launching a crowdfunding campaign, you should have a better idea about which is the best option for your startup. Between the two, which would you choose and why?
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