Crowdfunding vs Bank Financing

Our guide explains the pros, cons, risks, costs and alternatives of crowdfunding and bank financing before taking money that may be more expensive than it appears.

Updated 31 December 2022

Summary

Crowdfunding has seen a rise in interest in recent years – whether through New Zealand platforms such as PledgeMe and Snowball Effect or larger global platforms such as Kickstarter. Crowdfunding can be one of the ways founders raise capital and is a popular alternative to VC funding.
On the other hand, bank financing is a less well-known path that startup founders can take to fund their business. Bank financing is not suitable for all startups but can be a strong alternative to companies that generate consistent cash flows.

To help you understand your options, our research team has outlined the pros and cons of each option, must-know considerations and differences and alternatives. Our guide covers:

What is Crowdfunding?

Crowdfunding is a common way for a startup or founder to raise capital from the general public or non-institutional investors (e.g. not venture capitalists or banks). The startup company is typically listed on a crowdfunding website. The website's users can look through the provided documents and decide whether they believe in the company and the founder's mission. If they do, they're able to contribute money to the cause or in exchange for an equity stake.

Typically, companies pitching through crowdfunding platforms will need to provide a prospectus about the business, the idea and what they intend to do with the use of funds, as well as financial projections, cash runway and general market insights.

Crowdfunding provides ordinary New Zealanders with the option to invest in private companies that they may otherwise not be able to invest in – however, it's important to recognise that there are inherent risks with investing in early-stage companies. Most startups will fail within five years, and retail investors may not recognise this risk.

How Does Crowdfunding Work?

Crowdfunding typically aggregates many small cheques from various retail investors through pledges, investors, or individuals. The early supporters of the "campaign" can get either equity or early access to the finished product once it's done. When companies have yet to develop a product or idea (known as the "Proof of Concept" stage), it can be increasingly useful to raise through crowdfunding, given institutional investors may be hesitant to invest at this stage given the unproven nature of the product and the risky stage of the business.

Crowdfunding typically takes place on platforms like Pledgeme or Snowball Effect and can provide capital to businesses at a crucial time in their journey.

What is Bank Financing?

Bank financing is a form of financing provided by traditional banks (e.g. Westpac, ANZ or ASB). Banks usually provide businesses with loans where they need to pursue expansion, improve cash flow or develop a product. The nature of a bank typically means they focus on revenue-generating, stable businesses when considering providing bank financing.

Typically this bank financing will be in the form of a lump sum amount that will have an interest rate (fixed or variable) associated with it, and payback will be after a set period.

In general, startup loans are relatively uncommon. However, there are instances where banks can provide funding to startups. Typically, banks will look at the individual and their history to gauge whether the business has enough credibility to be lent to. This can include checking credit scores and taking collateral against any assets a founder may have.

If you don't have collateral (e.g. a house or vehicle) or you have a poor credit score, it can be difficult to get bank financing for your startup.
Bank financing is typically a long, drawn-out process with a lot of due diligence. Traditional lenders will have a credit range and a list of criteria they need to check off before providing bank financing.

Which one is Better - Crowdfunding vs Bank Financing?

Crowdfunding and bank financing are both useful avenues to pursue funding your startup. The sections below will analyse each pathway, but each startup differs with respect to their capital requirements, timeline and unique situation.

Pros and Cons of Crowdfunding

Crowdfunding has become popular in recent years off the back of platforms like PledgeMe, Snowball Effect and Kickstarter. Crowdfunding platforms provide entrepreneurs with a larger platform to pitch their ideas and raise money to turn them into a reality.

By raising money directly from the general public – it casts a much wider net on the potential sources of money and sidesteps the traditional gatekeepers of small business financing (e.g. Venture Capitalists or Banks).

Crowdfunding comes with unique pros and cons. On the one hand, some great New Zealand companies have gone through crowdfunding campaigns (e.g. Invivo, Zeffer, Ubco and Little Island all raised through Snowball Effect). However, there will be many others that have either failed to raise their target or have liquidated post-crowdfunding campaign (such as Mad Mex or Ed&I).

Pros of Crowdfunding

Quick way to test an idea or product - Crowdfunding allows you to see whether your idea is feasible without investing too much time and effort into the product. The feedback you get from using a crowdfunding campaign can be invaluable to the future development of your product or service. Reaching your target fundraising goal proves to the market that demand for your product/service exists. This can assist in further funding rounds from either VCs or banks.
Global reach - Some crowdfunding campaigns can go viral and get exponential exposure. If your startup hits this level of success – you'll likely be able to take advantage of this and grow faster than other startups in the industry.
Minimal dilution - Compared to other forms of funding (e.g. VC, angel investing), crowdfunding campaigns allow you to set the amount of dilution you are comfortable taking as a startup founder (e.g. anywhere from 0% to 30%+ depending on the raise size). Individual investors are typically less concerned or well-versed in valuation and metrics, so they may be more likely to invest in rounds where dilution is light. VCs can be strict on dilution and ownership stake, which can have an adverse effect on the founder's motivations in the future.
Larger network to pool funds from - Crowdfunding allows you to tap into a larger community or network. Creating a successful campaign can allow the startup founder to build a large community of their own. Together, this group of individuals can provide critical feedback the founder can use to make the product or idea stronger before raising subsequent rounds.
Crowdfunding success will rely on how well you pitch to individual investors or groups to support your idea - It will let you test your potential target market before you potentially take bigger cheques. This means you can test the waters on your idea before you invest further time and money into it. If there isn't enough appeal, your campaign won't take off, you won't have access to funds, and you'll be able to revisit your ideas.
Outsource administrative tasks - Crowdfunding platforms typically make the process as simple as possible, explaining clearly what documents you need to provide and, most of the time, will take care of pooling funds and legal documentation. They do take a fee for this, but it can alleviate many headaches when it comes to aggregating funds from many small individual investors.

Cons of Crowdfunding

Time commitment - Crowdfunding campaigns are as simple as they may seem. They require a lot of effort to draft up pitch decks, sort out the marketing and build a strong business proposition. Fundraising is one of the more stressful activities that founders do.
Crowdfunding requires a lot of upfront effort, and there's a chance your campaign may not meet the desired target. The pitch, due diligence documents and marketing will all need to be top quality. There are no guarantees that the effort you put in will yield any result.
Financial commitment - Setting up a crowdfunding campaign can cost more than founders think. From editing videos and paying for content writers to drafting legal documents and paying the crowdfunding platform, the whole process can cost thousands of dollars – this is typically before any money comes in from the crowdfunding campaign itself.
High likelihood of failure - Whilst crowdfunding platforms will likely increase your likelihood of getting funded, the risk your startup will fail is still there. Further, if the campaign doesn't meet its target, it can signal to the market that your idea may not be as strong. This can impact further capital raises, given the highly public nature of a crowdfunding campaign.
Aggressive fees - Crowdfunding platforms can provide a great platform for you to get your idea and capital raise out there – but it does come at a cost. Given crowdfunding is still a relatively new concept with few competitors; the incumbent providers typically charge significantly higher fees for listing with them. For example, Kickstarter takes 5% off the top of every campaign (not including credit card fees, transaction costs etc.).

Pros and Cons of Bank Financing

Pros of Bank Financing

Very low, fixed interest rates - In today's low-interest-rate environment, bank loans can be relatively inexpensive to take out. You may only be paying 3-4% yearly for substantial loan amounts. However, keep in mind that fixed interest rates may only be for short durations and variable interest rates are subject to fluctuations.
Predictable monthly payments - When you take out a bank loan, you're able to accurately predict how much interest you need to pay each month. If your startup generates steady cash flows, it can be favourable to take bank loans with steady interest payments that you know you're able to service.
Professional banker relationship - Crowdfunding campaigns can provide capital and early validation, but they don't provide the experience and expertise necessary to scale your startup. Taking a bank loan normally comes with a professional banker that you're able to work with and seek advice from. They may have experience with similar startups in your industry that they've loaned money to and can be a crucial sounding board for future product or market ideas.
You own more of your business - Unlike equity crowdfunding that typically dilutes founder ownership through giving up equity to investors, once a bank loan is paid in full, you still own the same amount of the company compared to before you entered into the bank loan agreement. This means it can be more lucrative to go with bank financing if you can make your loan payments.

Cons of Bank Financing

Know This First: Startups typically find it harder to get traditional bank loans. Banks are not typically set up to serve startups, and the high-risk nature of early-stage companies are not suitable for a bank's risk-averse nature. If a bank does approve your application, there are several drawbacks to taking a loan from them:

Due diligence document requirements - Banks can require a large number of supporting documents before seeking formal approval. There can also be a lack of transparency in the approval process, which may slow down things further.
Longer wait time - Bank loans will typically take much longer to apply for and get approval. Many banks have rigorous processes and due diligence checklists they need to go through before they can seek approval. The application process can range from one month to over six months. Startups with limited runway may be more time-pressed to raise funds quickly.
Requires strong credit - Good credit scores are essential for bank funding. If your credit score is weaker, you may have trouble qualifying for a bank loan. Banks typically require strong personal or business credit scores, collateral and stable cash flow. Without these, your application may be significantly weaker when going through the application process. Banks are reluctant to lend to borrowers with a weak personal credit score or a volatile business credit profile as they pose a greater risk.
Specific industry requirements - Banks have the infrastructure and processes for large loans. However, startups are typically looking for smaller cheques of between $100,000 to $1m.
The industry you're starting your business in will also impact your loan application. Some banks will not make loans to certain industries, which will result in automatic rejections. Some banks may have quotas per industry, which may have already reached a maximum amount of loans for the year – this will result in an automatic rejection. Industries like real estate, retail, and hospitality may be considered higher risk from the bank's perspective.
Variable-rate risk - You will know the terms of your loan when you sign your loan agreement. However, keep in mind that some payments will vary depending on how much you borrow. Some loans will have variable interest rates, meaning payments can change if interest rates change. Make sure you understand the terms and conditions of the loan before signing. Many banks can offer assistance or advice from a professional banker you can utilise when you have questions about the loan.
Traditional bank loans typically have a strict application and approval process, but the funds are confirmed once you've been approved and making on-time payments can help build your business credit. Qualifying for a bank loan is a cost-effective way to maintain cash flow to expand the business.
Loans are typically not ideal for startups. You'll likely be burning cash to build out your product or service, grow your team and scale your business. You likely won't be cash flow positive, and a monthly loan payment can really impact the cash flow of your business. Many startups have gone down the bank financing path only to find out they're out of cash and unable to meet their loan payments. Keep this in mind when considering bank financing.

Comparing Business Financing and Crowdfunding

Consideration	Business Financing	Crowdfunding
Source of Funding	The bank / online lender's balance sheet	The crowdfunding platform hosting the specific campaign will issue the funds after the capital has been pooled. The funding originally comes from multiple individual investors
Application Process	Banks will review your credit score, tax returns, financial statements and business plan before approving the loan. The approval process can be strict, drawn-out and difficult. The entire process for a bank loan to be approved will take approximately 1 - 2 months (but will ultimately depend on the bank).	With crowdfunding, there are two stages: (1) getting approved to list the company and (2) actually raising funds from investors. Campaign requirements and guidelines can vary depending on the platform (PledgeMe, Snowball Effect, Kickstarter etc.), but the process to get approved to list on the platform is typically faster than bank financing. The actual time it takes to fundraise the round, once approved, can take longer.
Fees	Interest is paid on the total loan amount. The interest rate is based on various factors, including credit scores, loan amount and nature of the loan.	Typically, crowdfunding platforms will charge a fee based on the amount of capital raised (percentage-based fee) and may also charge an initial one-time listing fee depending on the platform.
Additional Benefits	Banks provide lending to a wide variety of businesses. Some banks may provide guidance or mentorship if they have relevant industry experience in-house.	Crowdfunding platforms can provide visibility and access to investors the company may have not otherwise been able to market to.
Credit Requirements	Business loans typically require good personal and business credit scores.	Crowdfunding doesn't look at credit scores – so there are no requirements for this.
Repayment	Loan repayments come in the form of instalments, typically monthly or quarterly, until the loan is paid in full (principal and interest). Penalties and fees may be applied for late payment or defaults on the loan.	Crowdfunding may either be for equity (e.g. investors own a portion of your business), or they will be charitable in nature and may not have any hard requirements associated with them.

Alternatives Forms of Financing (Beyond Crowdsourcing and Bank Financing)

Other alternatives for startups include:

1. Angel Investors

Angel investors can also provide funding in the early stages of a startup and typically don't impose huge financial and legal burdens on founders. You'll have to give up an equity stake in your business, but in exchange, you may get an experienced business partner and mentor with valuable experience.
Angel investors can come in the form of friends or family, high net worth individuals or angel associations. See our Angel Investing guide below for more info.

2. Peer-to-peer lending (P2P)

P2P lending lets you borrow directly from one or more strangers. P2P lending can be a fast alternative to get financing without going through formal processes. However, finding suitable parties that will lend to you can be a challenge. Platforms like Harmoney are examples of P2P lending.
Technology has drastically reduced the barriers to lending, and now online lenders are competing with traditional banks for loans.
Many offer faster application processes and reduced payment times than banks that are typically process-driven and slower to react.
It's important to note that the terms and conditions may be more aggressive with respect to the interest rate or payback period.
Our guide to peer-to-peer lending has some relevant sections for anyone wanting to raise money.

3. Venture Capital

Venture capitalists can provide funding, networking and professional guidance to launch your business rapidly. See below for our NZ Startups guide for a comprehensive overview of the VC raise process.

4. Government Grants

Businesses focused on research and development, or innovation may be eligible for grants from the NZ government. The benefit of these grants is that they aren't typically expected to be paid back – which is effectively free cash flow for you to build out your business.

5. Revenue-based financing

Whilst not a common offering, recent startups have started to develop revenue-based financing options whereby loans are provided in exchange for % of future revenue. Recent examples include the Lighter Capital and NAB partnership, as well as overseas startup Pipe.

6. Bootstrapping

If all else fails, you could use your personal savings or assets to finance your business. Note that this is risky – if your business fails, this can impact not only you but your family.

Frequently Asked Questions

How can I ensure I have the best chance for crowdfunding and/or bank funding?

Two must-know considerations include:

The terms of crowdfunding platforms are important to read. There may be aggressive terms or clawback provisions when a company does not raise the full amount or provisions that require businesses to raise their full targeted amount to keep any of the money raised. Some platforms may have embedded fees that are not fully disclosed at the start (e.g. payment processing fees or management fees).
Crowdfunding is not a shortcut to the traditional capital raise process. Raising through these platforms can take the same amount of work to compile the necessary documents and, in some instances, can be harder to get traction if there are similar offerings on the platform.

How can I improve my chances of getting bank financing?

Have a clear and robust credit history. A bank is much more likely to give you a loan if you can prove you're responsible with money – both in a personal capacity and in a professional capacity.
Provide security/collateral (e.g. against a house) on the potential loan.
Ensure you're invested personally in your business
Previous experience in a startup (whether founded or as an employee)

Important: Get your business and financial plans in order. Understand how much cash you will need to expand the business and fuel it in the early days. This could be through runway, cash burn, salaries for key hires or expected capital expenditures. Being able to show the bank a realistic and clear plan that clearly stipulates (and ideally pay them back faster). Bankers are realistic and risk-oriented, so they will test your key assumptions. Also, payback and security are critical:

1. Clear payback plan for the business loan.

Including a budget showing how you'll afford repayments gives the bank more comfort your business can repay, lowering the risk of loaning you money.

2. Provide security or collateral

Your home, vehicle or other personal assets could be used as security. You might be able to get an unsecured loan if you're only looking to borrow a small amount, but you'll be much more likely to be eligible for a large business loan if you've provided other assets as security (collateral) on the loan.
Unsecured loans typically require higher credit scores and solid financial metrics, though typically, these are only offered to a bank's most creditworthy customers. Given startups may lack revenue and quality financials in the near future; collateral may be required to get a loan. Some banks may not lend you capital without upfront collateral.

What IP and trademark considerations do I need to make when going for crowdfunding?

Ensure your IP is protected and don't give too much information away. Because crowdfunding campaigns are public by nature, there's a possibility that another startup founder can take the idea you've got and create a "copycat" business from it. If it isn't protected with trademarks, patents or copyrights – it can be difficult to deal with later down the line. Either protect your unique IP before raising through the crowdfunding platform, or be intentionally vague around the commercially sensitive parts of your technology.