by arnohesse.

By Arno Hesse

Crowdfunding is to banks what Youtube is to Hollywood. The “long tail” of crowdfunding has enabled many businesses successes that wouldn’t have passed the filters and capacity of financial institutions. It is a fundamentally different model of underwriting, especially in food and agriculture.

Why is a bank loan for a small food business as rare as a warm evening in San Francisco? Low-visibility fog has something to do with it. A few years back, when I worked in Retail Banking, small businesses were among the customers my group focused on. Through many conversations with lenders and underwriters, I came to realize why most banks don’t like to lend to small businesses in food and agriculture: from the perspective of a bank office, these businesses appear damn hard to understand and underwrite.

Community members, on the other hand, are not only closer to a business’ Market (they are part of it!), they are also revenue-generating participants, not just its observing actuaries.

  • Restaurants have a reputation of rarely achieving profitability, or even surviving the first years. How should the bank underwriter know if the borrowing restaurant entrepreneur is a hit and miss in its market? People who live in the restaurant’s community are its customers and hear what reputation they have. Furthermore, they can be its customers and influence its revenues.
  • For Farms, the underwriter needs to travel far to get a first-hand perspective, for what is often not a substantial loan. The community is typically closer and a eating customer.
  • Food producers and processors do get some acceptance from banks, mostly when they use industrial equipment and commercial space that has resale value as collateral. Handmade food by small artisanal producers is often out of luck.

Banks will task their underwriters only to spend time on loans where the size and risk of the loan is expected to produce interest income that exceeds the underwriting cost.



The economics of crowdfunding calculate differently.

  • Donation-based crowdfunding campaigns don’t expect a return in the first place. Very often, they are passion-driven impulse decisions that involve only small amounts per funder. Quick decisions with small checks. The “risk” is the disappointment when the cause is not successful.
  • Campaigns that fund the go-to-market are successful when they reach a critical mass. The funders are also the customers. Their commitment creates the market that only a crowd can create.
  • Crowdfunded payments to a business, either to be repaid in cash (e.g. Kiva ZIP) or in-kind (e.g. Credibles), involve community intelligence in what we call Community Underwriting.

Especially when the repayments are in products and services (edible credits), the funders are part of the market. They have first-hand and social insights about the business. The tastebuds are involved in the underwriting. You wouldn’t pre-pay a business whose food you’re not a fan of. Once community members funded a business, it is in their best interest to become an even more loyal customers and bring your friends and family along. Imagine a bank underwriter getting that involved … In our early pilots, we have seen customers frequent a business 2x-4x as often once they prepaid the business.

Community underwriting can create its own self-fulfilling (positive) prophecies because the community members are not just assessing the market (like an outside banker), they are dynamic participants. (Sometimes, we will see even community insiders place a bad bet.) With the growing crowdfunding trend, though, communities can influence which of their enterprises that want to be sucessful – which ones they want to underwrite as a community and rally behind.

Getting funded Bank Underwriting Community Underwriting
Who decides Loan underwriter, often remote from community Many members of community
Entrepreneur’s prep Loan application with paperwork Build fanbase with good products and community engagement
Decision criteria Algorithm formula, based on industry, geography, credit score Social reputation of owner. Approval by tastebuds.
Loan amount Few large amounts Many small amounts
Mitigate risks Claim on collateral. (things with resale value) Support the business by promoting it among friends and family
After funding Collect loan payments. Cross-sell other services. Even more loyal customers; eat edible credits.

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