Some traditional sources of finance that are available are:
However, the problem with many traditional sources of finance such as banks and investors are that they involve a lot of time, red tape, paperwork, and they place a very large emphasis on past credit history, which most startups and small businesses don’t have.
Fortunately, due to the rise of digital solutions at fintech companies, some online sources of finance that overcome these hurdles are:
It has also become easier to access certain traditional sources of finance online, namely:
Crowdfunding refers to raising money for a new project or venture from a large number of people, who each contribute a relatively small amount. This is typically done via the Internet or a crowdfunding site, also known as a crowdfunding platform.
Modern day crowdfunding first began in 1997, when a British rock band raised money for its upcoming reunion tour from fans via online donations. This innovative idea gave birth to the first crowdfunding platform, called ArtistShare. Since then, the crowdfunding industry has been growing consistently each year, gaining significant traction in 2008.
There are four different types of crowdfunding available; these differ based on what is received in exchange for a contribution:
Crowdfunding takes place on a crowdfunding site, also known as a crowdfunding platform. Whether you are looking to raise or contribute funds, you will need to register with the website in order to participate.
Crowdfunding sites will typically list all projects or ventures that are being pitched on the website. Each project or venture should provide details such as:
Crowdfunding money goes to the project owner or venture only if it raises the full amount of the contribution goal stated in the pitch.
Crowdfunding is used for a variety of reasons, from raising money for a sick family member to launching a small business. Below are some common users that benefit from crowdfunding:
Crowdfunding is appropriate for all the users mentioned above.
It is also an option for small businesses that are unable to secure a bank loan or bring on an investor. Businesses encompassing the following factors generally have the most success with crowdfunding projects:
It is important to note that crowdfunding is most popular for personal financing, but it may not be the best solution for business financing, especially as an ongoing solution.
Whether you’re an individual or a small business, crowdfunding can be an effective way to raise funds. Here are five reasons why it works well:
There are five main reasons why crowdfunding may not be a good idea for some small businesses and startups:
Similar to fintech as a whole, crowdfunding is important because it helps out underserved markets that are unaddressed in the traditional financial ecosystem. Crowdfunding has made access to capital easier, faster – and in some cases, even possible at all.
For small businesses, crowdfunding helps bypass the red tape that blocks access to capital. According to a Global Entrepreneurship Monitor study, 95% of business plans received by venture capitalists and accredited investors have been rejected. Oftentimes, this is because a startup does not have enough years in business, a strong credit history, or proof of market demand.
Crowdfunding is also important because it helps individuals and organizations with a social cause. For example, a family member who otherwise would not be able to afford medical care for their loved one, or a local charity that can now expand its fundraising efforts to a global scale and raise more funds.
Yes, absolutely anyone can use crowdfunding. All you have to do is set up an account on a crowdfunding website, build a campaign, and post it. Some platforms will have certain requirements or an application process, which also need to be considered.
While crowdfunding can technically be used to start a business, it may not be the best option for first-time small business owners. This is because raising funds can take a long time, and the success largely hinges on having a large social media presence or existing community.
Yes, any nonprofit can take advantage of the benefits of crowdfunding. Just like any other fundraising activity, it is important that nonprofits review the laws that regulate fundraising in their region. For example, many states in the U.S. require nonprofits to register with the state before raising funds.
Yes, crowdfunding is an excellent way to raise funds for charities. Crowdfunding must be treated like any other fundraising activity and charitable registration is required.
There are many measures put in place by regulatory bodies and crowdfunding portals to ensure that the experience is safe. Below are some of the safety measures that are taken to protect users:
If you are investing in a crowdfunding venture or project, keep in mind that some level of risk will exist, as with most other investments. A good rule of thumb is to start small and diversify your investments across multiple sites.
From the four different types of crowdfunding listed above, two of these are regulated and two are unregulated. Donation-based and reward-based crowdfunding are not regulated, since the amounts are typically small and contributors are not receiving money in exchange.
Investment-based (equity crowdfunding) and loan-based (peer to peer lending) however, are regulated since they involve much larger amounts, and contributors receive money in exchange as well.
Canada regulates securities at a provincial level; each province and territory has its own securities commission and legislation e.g. the Ontario Securities Commission.
Within the U.S., crowdfunding is subject to oversight by the Federal Trade Commission (FTC). In order to operate, a crowdfunding platform has to register at a federal level with the Securities and Exchange Commission (SEC) and become a member of the Financial Industry Regulatory Authority (FINRA).
In addition to federal and provincial regulations, crowdfunding portals have their own standards that often exceed those required by regulators. Funding portals go the extra mile because they realize that in order to be successful, they have to offer the best protection for their users.
This question most often refers to equity crowdfunding, which is surrounded by a lot of misinformation and confusion.
In Canada, equity crowdfunding is legal under the Accredited Investor and Offering Memorandum exemptions. These are two exemptions that securities regulators provide to allow Canadians to raise funds from crowdfunding.
In the United States, equity crowdfunding is legal under Title III of the Jumpstart Our Business Startups Act (JOBS) as of May 16, 2016.
As of August 2017, all states permit some type of intrastate equity crowdfunding aside from a few exceptions.
The following states are in various stages of enacting or considering intrastate equity crowdfunding:
The following state has rejected intrastate equity crowdfunding:
The following states/territories have neither enacted nor rejected intrastate equity crowdfunding exemptions:
There are two main classes of investors for equity crowdfunding: ordinary citizens and accredited investors. Canada and the United States allow both classes to participate in equity crowdfunding within certain parameters. Some other countries only allow accredited investors to participate, or are bringing rules into motion that will allow ordinary citizens to invest.
Accredited or eligible investors are essentially high net worth individuals that meet certain income or asset holdings and are deemed to be more sophisticated investors by regulatory bodies.
In 2012 there were less than 500 crowdfunding platforms. Just two years later in 2014, there were over 1000 platforms and this number is continuing to rise.
What’s more, there are certain innovations taking place in the fintech space that will continue to encourage this growth:
Crowdfunding contributions are tax deductible under a donations-based model if the recipient of funds is a qualified charity. If you are donating to a business or other project, your contributions are considered personal gifts instead of tax-exempt donations.
The tax implications on crowdfunding funds will differ based on the crowdfunding model that is being used, as this will determine how the funds are labeled i.e. business income, gift, loan or capital contribution.
While there is no definitive guide on the matter – both the CRA and IRS do not have an official stance as yet on all aspects of crowdfunding – below are some basic guidelines.
Peer to peer lending means that borrowers can take loans from individual investors who are willing to lend their own money at an agreed interest rate. A peer to peer lending service essentially cuts out the middleman, such as a traditional financial institution.
Technically, peer to peer lending is a form of debt-based crowdfunding since a borrower can raise funds directly from multiple investors.
A peer to peer lending platform is a for-profit organization that connects borrowers with lenders, in order to facilitate peer to peer loans.
Peer to peer lending platforms request borrowers to fill out an application, who then assess credit risk, determine a credit rating, and apply an interest rate to their profile. Individual investors view the profile of a borrower and assess whether they want to risk lending money to them.
Borrowers can then receive the total loan amount from an individual investor, or multiple investors. In the case of the latter, monthly repayment has to be made to each of the individual investors. Borrowers tend to receive a lower interest rate than they would have gotten at the bank. All monthly repayments are made through the peer to peer platform.
Lenders generate income from the interest on the loan amount they provide to the borrower. The interest amount often exceeds what they would have received using a traditional vehicle such as a savings account at a bank.
If you are a lender, there will be a minimum amount you need to invest based on the lending platform you are using. The minimum amount is $25 for popular lending platforms in the United States. Companies will typically charge a percentage annual fee to investors.
In the United States, you need to make sure you live in an approved state and have a minimum gross annual income of $70,000.
As a borrower, you will need to fill out an online loan application found on the peer to peer lending platform.
Peer to peer lending took off in the mid-2000s when borrowers were getting frustrated with the banking sector’s dominance over the loan process. In 2015, Zopa was the first company in the world to offer peer to peer lending. The next most significant peer to peer lending company that launched was Funding Circle in 2010.
Peer to peer lending is one of the fastest growing segments in the financial services industry, with hundreds of sites across the world. As of 2017, the volume of global payments and remittances was over $1 trillion yearly, with per annum growth rates in peer to peer lending volumes reaching 50%.
As one of the fastest growing markets, the United States is predicted to hit 45% of the global market share in 2020 and generated $6.6 billion in loans in 2015.
Peer to peer lending can be safe or unsafe, depending on your lending strategy. If you lend to high risk borrowers, there is a higher risk of default. However, if you lend to lower risk borrowers with a strong credit rating, peer to peer lending will be safer.
Peer to peer lending is also more secure when you take a conservative approach and diversify your investments, instead of lending all your money to one borrower.
Peer to peer lending in Canada is regulated, however it is a process that is still evolving. Canadian securities regulators have taken the position that peer to peer loans could be ‘securities’, and therefore peer to peer lending platforms need to register as securities dealers at a provincial level. In some cases, Canadian peer to peer lending platforms need to file a prospectus if they are issuing securities.
To sidestep this requirement, many peer to peer lending companies are using existing exemptions such as restricting investment to accredited investors.
Within the United States, the lending side is regulated by the Securities and Exchange Commission. The borrowing side of the business is regulated by other agencies such as the Consumer Financial Protection Bureau and the Federal Trade Commission.
Yes, peer to peer lending is legal in both Canada and the United States. However, the regulations involved for companies to be legal are still quite complex and evolving.
Every state in the United States has their own set of lending rules and regulations and laws about investments in securities. Some states can borrow and not invest, some can invest but not borrow. And some can do both.
Lastly, it also depends on which peer to peer lending platform is being used, as some states are open to one, but not the other.
Depending on the platform, borrowers may face restrictions in:
Peer to peer investing is legal in all states aside from Ohio.
Interest earned from peer to peer lending is taxed, similar to other investment income. As an individual, interest income will be taxed at a marginal rate. Losses on loan defaults are also able to be deducted.
A business line of credit is an arrangement between a borrower and lender – typically a bank, but fintech companies are now an option – that allows for a maximum loan balance that the borrower can maintain and is subject to an interest rate. A borrower can draw funds from the line of credit at any time, as long as the maximum loan amount is not exceeded.
You can pay back any amount, so long as you make the minimum monthly payments that are set by the lender. These monthly payments can be a combination of interest and principal, or only interest.
Yes, you can apply for a business line of credit online through a lending institution’s website, by submitting an online application.
This is a lump-sum payment that is provided to a small business by a merchant account provider in exchange for a percentage of future credit card sales i.e. repayment is directly tied to future sales.
Merchant cash advance payments are automated and typically withheld by the credit card processor until the initial amount plus interest is paid back in full.
Yes, merchant cash advances are legal. Merchant cash advances are technically not loans, since they are a portion of future credit or debit card sales. Therefore, they are not bound by usury laws and can charge higher interest rates.
Although payments made towards the principal are not tax deductible, you can deduct the cost of interest on the loans. Overall, merchant cash advance loans will not protect your income from taxes and will also not subject you to additional taxes, so they are by and large tax neutral.
Cash advance online – also known as a payday loan – is a convenient way to get quick access to funds, but it can come with very high interest rates. Although the industry is regulated, borrowers need to take extra care in seeking out reputable lenders.
A much safer option is invoice factoring; this also provides quick access to a lump-sum amount, but at a much lower fee. For example, FundThrough is able to provide 100% of the invoice value upfront to customers with rates as low as 0.5%.
Invoice factoring is the process by which a business sells its invoices to a third party (called a factor) at a discount. This helps businesses with slow-paying customers meet their immediate cash flow needs and cover business expenses.
Invoice factoring is also known as accounts receivable factoring and accounts receivable financing.
An invoice factoring company will typically purchase an invoice in two installments. The first installment will cover approximately 80% of the receivable, and the second installment will cover the remaining 20%, less the factoring fee, once the client pays the invoice in full.
If you are a small business, these are the steps you would follow:
A factoring company will charge a factoring rate – or factoring fee – for their service, which is a percentage of the total amount of invoices being factored.
The factoring fee varies per business, and will depend on:
A typical factoring fee for 30 days will generally range from 1.5% to 4.5% per 30 days.
There is a difference between the total factoring cost and the factoring rate. To calculate your total factoring cost, you have to consider the two components: the factoring advance, and the factoring rate.
The advance is the percentage of the invoice that you get up front and is equivalent to the sum total of your first installment e.g. 80% of the total invoice. The factoring rate is the cost of financing, based on the value of the invoice.
For example, an 80% advance at a rate of 3.5% will have a total cost per dollar of 4.4 cents (0.035/0.80*100).
Invoice factoring is an excellent choice for small business owners that are looking for fast, ongoing access to cash at a lower rate than most other options.
These are the biggest benefits of using invoice factoring:
The difference between invoice discounting and factoring lies in who takes responsibility for collecting payment from debtors. With invoice factoring, the factoring company takes responsibility for collecting payments, whereas with invoice discounting, the business still retains control of collecting payments.
Invoice discounting also allows for more confidentiality; customers do not need to know a third-party factoring company is involved in assisting the business with its cash flow. With invoice factoring however, customers are making payments directly to the factoring company.
However, this is not the case with all invoice factoring companies. For example, FundThrough makes it possible for the payee to remain confidential.
Invoice factoring companies are not regulated by a formal government body, which allows them to serve small business owners that are unable to secure a bank loan.
Most invoice factoring companies are self-regulated and are members of associations such as The International Factoring Association and the Commercial Finance Association in order to ensure they are following best practices.