What is crowdlending? A startup founder’s guide

How crowdlending works for startups

The process typically begins with a startup creating a loan request on a crowdlending platform, detailing the amount needed, intended use of funds, and proposed repayment terms. 

The platform then lists this loan opportunity, allowing multiple individual investors to contribute small amounts toward the total loan amount. 

What this does—this democratized lending approach provides startups with an alternative funding source and offers individual investors the chance to diversify their investment portfolios.

Once the loan is fully funded, the startup receives the aggregated funds as a loan and must repay the principal plus interest over a specified period. 

Crowdlending vs. crowdfunding

Crowdlending and crowdfunding—although they sound almost the same—are two distinct revenue-generation models that leverage the power of collective financing, but they differ in key aspects. Let’s go over these: 

Crowdfunding

Crowdfunding is a broader term encompassing various methods of raising capital from a large group of people, typically for creative projects, causes, or early-stage startups. It often involves donations, rewards, or equity in exchange for contributions. It works well for creative endeavors, non-profit initiatives, and early-stage startups looking to validate their ideas and build a community of backers.

Crowdlending

Crowdlending, also known as P2P lending, is a specific form of debt-based crowdfunding where individuals or businesses obtain loans from multiple investors through online platforms. Crowdlending always involves financial returns through interest payments. So, the debt is paid back with interest.

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Traditional loans vs. crowdlending

Crowdlending and traditional loans are two distinct financing models that offer different pros and cons for businesses seeking capital. 

Traditional loans, typically provided by banks or financial institutions, involve borrowing a lump sum with structured repayment terms and interest rates. To get approved for these loans, typically, the startup must have a strong credit history, collateral, and a detailed business plan. 

Why do some businesses prefer traditional loans? They are favored for their ability to provide large amounts of capital and predictable repayment schedules. 

On the other hand, crowdlending connects businesses directly with individual investors through online platforms. In fact, crowdlending can act as a marketing campaign. This model often offers more flexible terms and a faster application process compared to traditional loans.

Traditional loans vs. crowdfunding: Which is best for your startup?

On the one hand, traditional loans are generally more effective for established businesses with solid financial track records and collateral. They're particularly suitable for companies seeking substantial amounts of capital for long-term investments or expansion. 

The predictability and structure of traditional loans can be beneficial for businesses with stable cash flows. 

On the other hand, crowdlending is particularly effective for companies seeking smaller loan amounts, faster access to capital, or those that may not meet the stringent requirements of traditional lenders. 

Crowdlending can also be advantageous for businesses looking to build a community of supporters or validate their market appeal. It's important to note that while crowdlending may offer more accessibility, it can sometimes come with higher interest rates depending on the platform and the business's risk profile. 

Important to note: When looking at the two options, compare the interest rates offered by the financial institution (if going the traditional loan route) and online platform (if going the crowdlending route).

Ultimately, the choice between crowdlending and traditional loans depends on factors such as the business's stage, credit history, funding needs, and long-term financial strategy. 

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Types of crowdlending platforms

Now that we’ve reviewed what crowdlending is, let’s go over the types of platforms through which to get funding. 

Crowdlending platforms typically operate under two main models: the three-party model and the four-party model. 

Three-party model

In the three-party model, also known as the client-segregated account model, the platform directly connects borrowers with lenders without involving a bank. 

Funds are exchanged directly between parties, and the platform manages a legally segregated client account to hold and transfer funds. 

This model offers more direct interaction between lenders and borrowers, potentially leading to faster transactions and more flexible terms. However, it may carry higher risks for lenders due to less regulatory oversight.

Four-party model

The four-party model, also called the notary model, involves an additional party, typically a partner bank. 

In this setup, the platform acts as an intermediary, matching borrowers with lenders, while the bank issues the actual loans. 

The bank's involvement adds an extra layer of due diligence and regulatory compliance, potentially reducing risk for lenders. However, this model may result in slightly lower returns due to additional fees and potentially stricter lending criteria. 

Three-party model vs. four-party model: Which model is best for your startup?

Both models have their advantages and trade-offs in terms of risk and return. 

The three-party model often offers higher potential returns but with increased risk, while the four-party model generally provides more security but potentially lower returns due to the additional costs and regulations involved.

Advantages and risks of crowdlending

Crowdlending advantages 

One of the main benefits of crowdlending is its accessibility to funding, as it often has less strict qualification requirements compared to traditional loans. 

This can be useful for startups or businesses that have a limited credit history. 

What’s more—crowdlending platforms typically provide faster access to capital, with the process often taking just a few months compared to the lengthy procedures of traditional lending. 

Additionally, crowdlending can serve as a form of market validation, demonstrating demand for a product or service and acting as proof of concept. 

Lastly, and this is a big one for startup founders, crowdlending allows businesses to retain full ownership, unlike equity-based funding options.

Crowdlending risks

However, crowdlending also comes with significant risks that businesses must consider. 

One major concern is the higher likelihood of failure compared to ventures funded through traditional means, as crowdfunded businesses may lack the seasoned professional guidance often provided by venture capitalists, angel investors, or startup incubators. 

There's also an increased risk of seeming to be fraud on crowdlending platforms, as some scammers set up dubious ventures to attract investments. 

Cybersecurity is another significant risk, as the online nature of crowdlending makes it vulnerable to hacking attempts, phishing schemes, and identity theft. 

In terms of interest rates, businesses using crowdlending may face higher interest rates depending on the platform and their risk profile. 

Lastly, there's the risk of reputational damage if a business fails to deliver on its promises, as crowdlending often creates a community of invested supporters who expect results.

How quickly can you get capital through crowdlending?

The exact amount of time can vary depending on the platform and the specific circumstances of each loan. Crowdlending generally offers faster access to capital compared to traditional lending methods, with some loans potentially being funded within a few days to a couple of weeks.

Typical interest rates in crowdlending

It depends. Interest rates in crowdlending can vary widely. Factors taken into account include the borrower's credit profile, the type of loan, and the platform. 

Wrap up

Crowdlending enables businesses to secure loans directly from individual investors through online platforms. It’s an approach that offers more flexible terms and faster processing times compared to conventional loans. 

That said, having enough capital is essential for a startup’s success. As you grow your business, focus on what matters—your product and customers. Rho's finance platform helps you manage cash and automate finance busywork, so you can focus on growing your business.

With Rho's Corporate Cards, you can make the purchases you need to keep your business operations running smoothly, all while enjoying up to 1.25% cashback¹. Combined with our expense management platform, you can make more strategic spending decisions and gain the insights you need to take control of your budget.

Want to learn more? Schedule time with a Rho finance expert.

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