The Ultimate Glossary of Loan Crowdfunding
Because loan crowdfunding is such a new means of raising capital for a small business, we wanted to equip you with a glossary of all sorts of useful definitions! Whether you’re a small business owner, an investor, or someone just interested in the world of crowdfunding, you should be able to find answers to most of your basic questions here.
Regulation Crowdfunding is an SEC-regulated form of raising money for a business. It consists of businesses offering securities (either debt or equity) to investors through a specified platform. Regulation Crowdfunding was made possible by the 2016 JOBS (Jumpstart our Business Startups) Act, and allows both accredited and unaccredited investors to invest in small businesses.
A crowdfunding portal is a platform like Honeycomb Credit which connects small businesses that are raising funds with investors. Portals do not hold the money or collect interest on the amounts raised, but rather provide a secure destination for investors and small businesses to find each other.
Equity crowdfunding is a version of Regulation Crowdfunding where businesses can raise money through shares of equity. This means that the business owner is offering up a portion of their profits to investors in exchange for an up-front investment.
Debt crowdfunding is a version of Regulation Crowdfunding where businesses can take loans out from community investors. Instead of offering up shares of equity, or paying interest to a bank, a business instead pays interest to individuals who have invested in their campaign. Debt crowdfunding is the kind of crowdfunding that Honeycomb Credit does.
Gift crowdfunding is an unregulated form of crowdfunding where individuals, businesses, or other organizations can raise money without the expectation of paying it back. This form of crowdfunding is seen on platforms such as GoFundMe, and is commonly used for charitable purposes such as paying off medical bills or recovering from disasters.
Reward crowdfunding is an unregulated form of crowdfunding where one can raise money without the expectation of paying it back. However, often in reward crowdfunding, the issuer offers “perks” such as free merchandise or special opportunities to people who contribute certain amounts of money. Some famous examples of reward crowdfunding portals are Kickstarter and IndieGoGo. While some businesses have found success in reward crowdfunding, the lack of financial incentives makes it difficult to reach one’s goals.
A crowdfunding campaign is the term used for the period in which an issuer is actively raising money for their purpose. During a crowdfunding campaign, typically a campaign page is created and the issuer promotes their campaign to their followers with the purpose of raising as much as they can. A typical Honeycomb crowdfunding campaign lasts 30-45 days.
The minimum goal is the minimum amount of money that needs to be raised on a crowdfunding campaign in order for the issuer to take the money home. Some portals operate on an “all or nothing” format, where if the minimum is not met no money is issued and people who invested or contributed to the campaign get their money back. Others, usually gift crowdfunding, allow issuers to take whatever they raise, even if it is very little. In debt crowdfunding, the minimum goal is the point where an issuer can begin taking out money to begin working on their growth project, and still continue to raise until the campaign’s end date.
The maximum goal is the maximum amount of money that can be raised on a crowdfunding campaign in relation to an issuer’s goals with the growth project. Usually, this is the total amount that a business needs in order to complete the specified project they are raising money for. Once a campaign has reached its minimum goal, it can continue raising funds until it either reaches its maximum goal or time runs out on
Business Lending Terms
Traditional financing is financing that comes from sources such as banks or accredited investors. There has been a distinct downward trend in lending from banks to small businesses in recent years, making it difficult for small business owners to access funding they need to grow. Investors can be rare to find for small businesses at certain stages, plus they take a portion of the business’s profits.
The Small Business Administration
The Small Business Administration (SBA) is a great federal resource for small businesses throughout the United States. They are often considered a traditional financing source, however that is somewhat of a misnomer. The SBA standardizes the loan process between small businesses and banks, but they themselves do not give out money. That being said, SBA lending is down as well for small businesses, so often alternatives must be sought out.
Merchant Cash Advances
Merchant cash advances are an alternative source of financing commonly taken on by businesses who have no other options or are in need of fast cash. Lenders such as Kabbage, Square Capital, and PayPal all make it easy to access loans, but these loans are often incredibly expensive - with APRs reaching as much as 200% or more!
Equity is a common means of financing for small businesses. The business connects with investors interested in putting money into it in exchange for a portion of the profits, and possibly an ownership interest. This can be a great way of forming a partnership, but might not be preferred by small business owners who are more independent or do not wish to break up profits.
Debt is a common means of financing for small businesses in the sense that a business takes out a sum of money which it intends to pay back, usually with interest. Debt can be taken out from banks, from individuals, or through crowdfunding portals.
An amortized loan is one where there are fixed payments throughout a period. When a Honeycomb loan is repaid, it’s paid off in quarterly installments that make up a portion of the principal plus the interest. An added bonus of Honeycomb loans is that there are no early repayment fees, so if a business chooses to pay off its loan quicker, it will receive no penalty.
Escrow is when a third party holds onto large amounts of money until a condition is met. When an investor invests in a Honeycomb campaign, their investment is held in an escrow account (not on Honeycomb) until the campaign’s minimum goal is met and/or the campaign ends, after which it is sent to the small business to put to work. When it’s time to pay back the loan, the business puts their repayment back into the escrow, where it is distributed back to investors.
The interest rate is the amount that a business pays back on top of the principal amount they take out. Essentially, the interest rate is the payment for the use of the money that the investors put into it. Honeycomb interest rates range from 5-12% on average, and are based on the level of risk that an investor is taking on in investing in a business. Also, the interest rates at Honeycomb all are returned directly to investors, not to us and not to any other party, so business owners can be assured that they are paying back their community, not a bank.
Fixed-Income Interest Rate
A Fixed-income interest rate means that the investor can expect a steady stream of predictable income from the interest and principal repaid back to them by the loan over the (3-5 year) period of the repayment schedule, assuming the business is able to repay back as planned.
The principal is the amount of money raised initially for the loan, before interest. In an investor’s perspective, it’s the amount of money they put into the crowdfunding campaign, expecting to receive that back plus interest over the course of the loan’s repayment schedule.
All businesses that crowdfund through Honeycomb are vetted. They undergo credit analysis and due diligence, including a review of historical financial documents, debt schedules, business plans, and organizational documents. This helps make investment decisions more secure, although all investments do carry risk and investors should be prepared to lose some or all of their principal, no matter how vetted the business is.
The return is the amount of money you expect to receive back after making an investment. For an investor on Honeycomb, your expected return is your principal back plus interest.
An accredited investor is someone who either has a net worth of $1,000,000 or more or an annual net income of $200,000. Before the JOBS Act, accredited investors were the only kind of people who could invest, meaning anyone below those means did not have the opportunity to invest.
An unaccredited investor is an individual who does not have $1,000,000 in assets or a high net income. Anyone over the age of 18 can now invest up to $2,200, and that number can increase as one’s net worth increases. The JOBS Act made it possible for unaccredited investors to invest in businesses, and portals such as Honeycomb make it easier for them to make investments by connecting them to issuers looking for funding.
A secured investment doesn’t necessarily mean that there’s any less risk involved in the investment, it just means that the business has put up some form of collateral or guarantee on the loan. This is not necessary for a business to take out a loan on Honeycomb (as it sometimes is for bank loans), but is often common as an extra security to the loan.
Impact investing is investing not just for the potential of financial gain, but also for a social or environment impact. Many investments made on Honeycomb could be considered an impact investment as they often benefit businesses that benefit their neighborhoods or are run by under-represented and under-resourced communities.
We promise we won’t quiz you…
But now that you’re an expert on the vocabulary needed to get into loan crowdfunding, are you ready for the next step?
If you’re a small business owner interested in funding your growth with crowdfunding, fill out the form below and we’ll be in touch!