In the last few years, alternative funding options like crowdfunding and peer-to-peer lending or P2P lending have become more popular as options for funding for both individuals and businesses. While both involve connecting people who need funds with those who have money to invest, they are fundamentally quite different in how they operate. Whether you are an entrepreneur, a small business owner, or just need a personal loan, knowing the two models will guide you to choose which would better serve your needs.

In this article, we are going to break down what crowdfunding and peer-to-peer lending are, explore their pros and cons, and help you make the best choice.

What is Crowdfunding?

In crowdfunding, you have to raise money from a lot of people, usually via online platforms. Most crowdfunding is aimed at creative projects, startups, or community-driven initiatives. There exist different types of crowdfunding, but for this discussion, we consider the two main categories: reward-based crowdfunding and equity crowdfunding.

Reward-Based Crowdfunding

Probably the best-known is reward-based crowdfunding, such as Kickstarter or Indiegogo. There, a person pitches an idea-for example, launching a niche product or filming a movie-and then asks people for money in return for a reward, maybe getting early access to that product or a special mention in the credits of a film.

Here, one gets to realize that contributors do not invest in the proper sense. They are actually supporting a project they believe in, but in this respect, they do not necessarily look forward to profit flow. It is more passion oriented than profit oriented, and once one has pledged, one cannot gain or lose from the financial success of the project.

Equity Crowdfunding

Equity crowdfunding operates more like traditional investing, where individuals contribute money to a business  in exchange for shares. This model is common among startups or early-stage companies looking for capital to grow. Platforms like Seedrs or AngelList facilitate this type of crowdfunding.

From the business owner’s perspective, equity crowdfunding is attractive because, if the business fails, they don’t need to repay investors. On the other hand, investors are taking on significant risk. If the business succeeds, they  could see substantial returns, but if it fails, they could lose their entire investment.

Pros of Crowdfunding:

• No repayment required (in reward-based crowdfunding).
• One has the potential for a huge success if  the project resonates with a large audience.
• Community building by engaging backers who are emotionally invested in your project.

Cons of Crowdfunding:

• High failure rate: A lot of campaigns don’t meet their funding goals.
• No guarantees: In equity crowdfunding, the  business could fail, and investors may lose their money.
• Limited liquidity: Shares in crowdfunded businesses are not easily sold.

What is Peer-to-Peer Lending?

Peer-to-peer lending, on the other hand, is a method of borrowing money directly from individuals rather than through a traditional bank. Platforms like LenDenClub connect borrowers with lenders who are willing to lend money in exchange for interest payments.

This form of lending is typically more accessible to borrowers with less-than-perfect credit or those who need quick access to funds. Also, lenders can generate returns in the form of interest; such interest is usually higher than what is found in other traditional financial instruments.

In P2P lending, borrowers take out loans for personal and business purposes. The loan is repaid over time with interest, and lenders earn returns based on these interest payments.

Pros of P2P Lending:

• Risk Assessment: Mandatory thorough credit checks on borrowers to reduce the risk of default for lenders.
• Regulated Platforms: All P2P lending apps must be registered with RBI and have NBFC- P2P license.
• Increased Loan Limits: Lenders can now lend up to ₹50 lakhs across P2P platforms, allowing for more diversified portfolios.
• Higher Returns: Compared to traditional investments, P2P lending offers higher interest rates, increasing potential returns.
• Faster Access for Borrowers: The online, streamlined process provides quicker access to funds than traditional bank loans.

Cons of P2P Lending:

• Risk of Default: Despite credit checks, borrowers can still default, which leads to a loss of investment.
• No Guaranteed Returns: Unlike fixed deposits, P2P lending does not guarantee interest or principal return.
• Investment Caps: RBI sets a limit on individual lending amounts, which could restrict larger investors.
• Unsecured Loans: P2P loans are often unsecured, lacking collateral, which increases the risk for lenders in case of default.

Key Differences Between Crowdfunding and Peer-to-Peer Lending

Ownership vs. Loan Obligation - One of the most important distinctions between crowdfunding and P2P lending is ownership. In equity crowdfunding, investors get a stake in the business. They become part-owners, and their return depends on the success or failure of the business. If the business thrives, they might see a significant return on investment. If it fails, they lose their stake.

In P2P lending, however, there’s no ownership involved. Lenders lend a certain amount, which the borrower must repay with interest.

Funding Model- Crowdfunding, that is reward-based, often operates on an all-or-nothing model, meaning if the funding goal isn’t met, the project gets nothing. This can be a huge risk for project creators, as even 90% of the goal could mean failure.

In P2P lending, there’s no all-or-nothing requirement. Borrowers receive the loan as long as they meet the platform's requirements and can repay the amount.

Use Cases

Crowdfunding is generally better suited for creative projects or startup businesses that are looking to raise large sums of money from a wide audience. It’s also a great way to build a community around your product or idea, as backers often become long-term supporters.

P2P lending is more suited for personal loans and small business loans.  It’s ideal for borrowers who need quick access to funds and are willing to repay with interest over time.

Choosing the Right Option for You

Deciding between crowdfunding and P2P lending depends on your unique financial needs and goals.

When to Choose Crowdfunding:

• You’re launching a creative project or a new product that could generate buzz.
• You don’t want to take on debt and prefer not to repay anyone.

When to Choose P2P Lending:

• You need quick funds
• You can repay the loan within the agreed time frame and interest terms.

Conclusion

Both crowdfunding and peer-to-peer lending are excellent alternatives to traditional finance, but they serve different purposes. Crowdfunding is best for those who are looking to raise capital without taking on debt, especially for creative projects or startups. P2P lending, on the other hand, is more suited for personal loans or business ventures where a quick loan with an interest repayment plan is more appropriate.

Ultimately, the right choice for you depends on your funding needs, your tolerance for risk, and whether you're comfortable with repayment obligations or giving away ownership in your business. Evaluate your options carefully to make the best decision for your financial situation.

(This article is part of DMCL Consumer Connect Initiative, a paid publication programme. DMCL claims no editorial involvement and assumes no responsibility, liability or claims for any errors or omissions in the content of the article. The DMCL Editorial team is not responsible for this content.)