Is Crowdfunding a Long-Term or Short-Term Source of Finance?

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Crowdfunding is a method of raising funds for startups and small and medium enterprises by pooling money from a large number of people. It is an alternative to more traditional methods of financing a business, such as private loans from financial institutions.

Before determining whether crowdfunding is a long-term or short-term source of funding, let us try to answer the following.

What exactly do we understand by “Sources of Finance”?

What is a short-term finance?

What is a long-term finance?

Sources of Finance

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Sources of finance, as the name implies, refer to the methods through which a company finances its venture. Businesses determine which source to choose, depending on their financial needs. A startup, for example, might crowdfund its initiative while retaining the equity. Others, however, may choose to support their business with direct loans from investors in exchange for share.

Classifying the Sources of Finance

Sources are categorized in multiple ways, depending on investor, ownership, and time-period among various things. On the basis of time-period they are classified under short-term medium-term and long-term sources of finance.

Short-term Sources of Finance

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Short-term sources of finance are used to raise funds for a limited time period, usually less than a year. As a result, all funds raised must be repaid within a year. These are typically used to cover any financial shortfalls, and the amount of money that can be collected is limited. Examples include commercial paper, promissory notes, and letters of credit.

Medium-term Sources of Finance

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Medium-term sources of finance allows funds to be repaid after a year but before five years from the date they were borrowed. Examples include term loan borrowings from financial institutions and commercial banks. For publicity and advertising initiatives, a medium-term strategy is usually required.

Long-term Sources of Finance

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Long-term sources of finance are used to raise funds for projects that will last longer than a year. The money can be repaid over a long period of time. When a company is striving to expand, they are usually sought. It is also preferred for capital investments or other long-term initiatives such as acquisitions, the establishment of a new facility, and share repurchases. Because there are no constraints on the funds that can be raised, large sums of money can be raised. Examples include Term loans, Venture capitals and Equity.

What type of Source of Finance is Crowd funding?

Crowdfunding is a short-term source of finance. To better explain it let us consider the following key ideas in short-term sources of finance.

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1. Short term sources of finance allow funding for not more than 1 year. Crowdfunding too takes place over a small period of time. Even the top campaigns do not generally extend for more than 6 months.
2. The quantity of money that can be raised via short-term sources of finance is limited. Crowdfunding is also preferred for generating small amount of funds.
3. Short term sources of finance does not require collateral or security. This is especially true in the case of crowdfunding, where you can start a campaign for free and are charged only when you have reached your goal.
4. Lenders are quick to approve short-term sources of finance. Startups can also easily set up Crowdfunding campaigns online. Most crowdfunding platforms, such as FundingX, respond within 24 hours and, after confirming the product, allow startups to host it on their platforms. Investors are also quick to respond to the initiative. While the reasons for success of campaigns differ, and any successful campaign requires more than just investors, it is clear that investors approve of crowdfunding campaigns.
5. Any delay in obtaining funds from short-term sources of finance puts the startup's projects on hold. This is one of the key aspects of crowdfunding. A crowdfunded campaign thrives only when the investors fund it. If they cease funding a project, the startup would both fail to meet its monetary goal and would be rendered incapable of working on the project.
6. Through short term sources of finance, startups pay lower interest rates since the funds generated are not high. In this way, crowdfunded campaigns are also cost effective. Crowdfunding websites often charge minimal fee. For instance, FundingX’s basic package costs 5% of the total fund raised. Because crowdfunding is predominantly a reward-based or donation-based model, entrepreneurs do not have to repay their investors and they therefore retain most of their equity.

From the above, it may be therefore inferred that crowdsourcing is a short-term source of finance. As an alternative to personal loans and other forms of sources of finance, crowdfunding streamlines the process of generating funds for companies and opens up the market to innovators.