Difference between debt crowdfunding and lending crowdfunding

When it comes to debt capital and crowdfunding, one often thinks only of lending crowdfunding. This is because for years lending crowdfunding has been the only way to raise debt capital in the crowd.

But since 2019 debt crowdfunding also exists, a somewhat generic label that could increase confusion. Both debt crowdfunding and lending crowdfunding belong to the realm of debt capital raising, that is, transactions in which a company receives money by committing to return it over time with a return for investors. However, the financial and legal mechanism behind the two operations is different. 

In lending crowdfunding, in fact, the company receives a loan from a plurality of investors through an online platform.

In debt crowdfunding, on the other hand, the company places through online platforms debt financial instruments, such as Minibonds or bonds.

The distinction may seem technical, but it has very important practical implications for both businesses and investors and results in different regulatory references.

In this article. We help companies seeking debt capital understand the difference between debt crowdfunding and lending crowdfunding to choose the tool best suited to their needs from the online opportunities.

What is lending crowdfunding 

The lending crowdfunding is a form of online group lending - also called peer-to-peer lending o social lending - in which a multitude of investors lend money to a company through an authorized platform. 

The relationship between the company and investors in this debt mode arises from a financing contract. In fact, the underlying normative reference is the mortgage contract as described in the Civil Code.

What is debt crowdfunding 

The debt crowdfunding Instead, it is an online capital raising based on the issuance and placement of debt financial instruments, such as classic bonds or Minibonds.

Here, the relationship between investor and company arises from the underwriting of an actual financial instrument, a debt security. This means that debt crowdfunding is closer in logic and structure to the traditional bond market than peer-to-peer lending. 

In the Italian context, debt crowdfunding since the Finance Act of 2018 for 2019 has been gradually recognized as a separate category from both equity crowdfunding and lending crowdfunding, especially with The opening of online platforms to the placement of minibonds and debt securities for SMEs. 

The confusion between lending crowdfunding and debt crowdfunding

The understandable confusion stems from the fact that both debt modes share some basic characteristics:

• Online capital raising;
• Involvement of a plurality of investors;
• Capital repayment commitment;
• Presence of interest or financial return.

However, in lending crowdfunding a loan takes place, while in debt crowdfunding a debt financial instrument issue takes place.

Let's see what this difference entails.

How lending crowdfunding works 

In lending crowdfunding, a company raises capital by borrowing from a plurality of investors through an authorized online platform. 

We will not dwell here on the practical steps of a lending crowdfunding campaign, because we have already covered the topic extensively in our full article on lending crowdfunding. 

Here we only remind you that upon completion of the capital raising, companies that have launched the lending crowdfunding campaign must Repay the principal and pay out the interest to lenders according to the terms set at the outset, i.e., with a bullet amortization schedule (repayment of principal at maturity, interest disbursement at maturity or in periodic installments) or amortizing (gradual repayment of principal through periodic installments including principal + interest).

How debt crowdfunding works 

When we talk about debt crowdfunding, in Italy we mainly talk about Minibond. These are debt financial instruments issued by unlisted companies to raise capital from outside investors.  

Economically, they function similarly to traditional bonds: the company issues a debt security, receives capital from investors, and agrees to return it over time along with a yield. 

In Italy, minibonds were introduced with the Development Decree of 2012 for Facilitate SMEs' access to the capital market and reduce dependence on bank credit. Compared to traditional bonds, in fact, referred to as Bonds, Minibonds have a smaller denomination (max. 50 million euros) and can also be placed by unlisted companies.

The Finance Act of 2018 then added the possibility of also placing them through crowdfunding platforms authorized, to further increase the accessibility of the instrument and the audience of potential investors.

In debt crowdfunding through Minibonds, the company defines the characteristics of the issue together with advisors, consultants, and platform. 

The main variables to be determined are:

• total amount of the issue;
• duration;
• interest rate;
• mode of reimbursement;
• any guarantees;
• financial covenants;
• target investors.

Once the transaction is structured, the Minibond is placed through an online platform.

Compared to lending crowdfunding, therefore, the process is a bit more complex and requires more substantial documentation and unavoidable legal support.

This is why debt crowdfunding tends to be used mostly by companies that are already mature and have a relatively sound financial structure, as we shall see.

You can also learn more about Minibonds and how they work In the article devoted to crowdfunding for Minibonds..

Operational difference between debt crowdfunding and lending crowdfunding

From the perspective of the enterprise, lending crowdfunding and debt crowdfunding may seem similar because they both allow people to raise debt capital online. 

However, the operational and regulatory differences are profound.

As we have already mentioned, in lending crowdfunding the regulatory basis is that of loan and loan agreement. In debt crowdfunding, the regulatory basis is that of bond financial instruments, with specific decrees for Minibonds dedicated to SMEs.

Both types of crowdfunding, today, undergo the broader European regulation for crowdfunding service providers (ECSPR), but the national regulatory roots remain valid. 

In addition, the ECSP regulation also provides at least one regulatory difference between debt and lending: Anyone can participate in a lending crowdfunding campaign, but only professional (“sophisticated”) investors can subscribe to Minibonds issued by LLC enterprises. Minibonds issued by spa enterprises, on the other hand, are also open to non-professional (retail or “unsophisticated”) investors.

From an operational point of view, In lending crowdfunding:

• preliminary operations are more streamlined;
• amounts tend to be smaller;
• execution times are generally faster;
• any business with a minimum of historicity and financial sustainability can launch a campaign.

In debt crowdfunding, instead:

• the structuring is more complex;
• investors are often more sophisticated;
• the amounts collected can be higher;
• it is necessary for the enterprise to have experience, soundness, well-structured internal governance, more economic resources.

It also changes the typical objectives Of enterprises using either instrument.

Lending crowdfunding is often used for:

• operational needs;
• real estate development;
• bridge financing;
• liquidity support;
• Short- or medium-term projects.

Debt crowdfunding through Minibonds, on the other hand, is most frequently used for:

• structured industrial plans;
• corporate growth;
• international expansion;
• debt refinancing;
• medium- to long-term investments.

Not only that: Minibond placement also serves as a training ground and springboard to prepare for an IPO. Not only for the preliminary procedures that partly resemble those required for listing. These securities, in fact, after placement can also be listed on a specific and simplified platform compared to the classic regulatory market: Extra Mot Pro3, created ad hoc by Borsa Italiana. Or even on similar foreign markets. 

Minibonds thus become nimbly exchangeable-this is another fundamental difference from lending crowdfunding, which for investors is a assets with low liquidity.

Lending crowdfunding or debt crowdfunding: which to choose? 

Because of the differences we have described in the previous section, the choice between the two instruments depends not only on the cost of capital, but mainly on the maturity level of the enterprise and the type of financial transaction to be carried out. 

Lending crowdfunding is particularly suitable for the SMEs that need to raise capital relatively quickly to support concrete operational needs. 

For example:

• Purchase of machinery;
• increase in inventory;
• opening of new locations;
• order financing;
• liquidity support;
• commercial or marketing campaigns.

Not surprisingly, one of the sectors in which lending crowdfunding has become most popular is real estate: in the’article on the success of real estate lending crowdfunding We explain all the reasons. 

In general, for many SMEs, lending crowdfunding is a more agile and flexible way than bank lending, but also than Minibonds, to finance specific operations without going through too long or complex processes. 

It is precisely its agility and flexibility that make it a suitable instrument also as a supplement to other types of financing, coverage of temporary liquidity needs, and bridge financing while waiting for slower liquidity events.

Debt crowdfunding through Minibonds, on the other hand, is mainly aimed at companies with an already sound financial structure and organized and effective governance: it is the most suitable choice for Established SMEs, companies with structured balance sheets and a robust financial history. It is not one startup tool, in short. 

From a needs perspective, Minibonds are a better choice for larger, medium- to long-term capital needs than lending crowdfunding.

Finally, as we have already mentioned, debt crowdfunding can be not only a source of financing, but also a strategic step toward greater openness to the capital market. 

They can choose it, therefore, businesses that want to outline a path to listing on the stock exchange But they are not yet ready to take the plunge.

Indeed, with the issuance of Minibonds, one begins to experience the processes imposed by the dynamics of the regulated market: periodic reporting, investor relations, covenants and their monitoring, and greater formalization of governance.

In conclusion, The difference between debt crowdfunding and lending crowdfunding is a key compass for choosing the tool best suited to the maturity and goals of each enterprise.

Finally, as with all forms of crowdfunding, it should be remembered that success depends not only on the quality of the financial instrument used, but also on the company's ability to build trust, communicate the project and properly manage the relationship with investors.