Types of crowdfunding
There are four main identified types of crowdfunding:
- Donation – money is pledged for no specific tangible return. It is used for Charitable causes, where funds are raised for social and environmental purposes. Donors come together to create an online community. The aim is to get around a common cause to help fund services and programs to combat social and environmental issues;
- Equity – where a percentage of a community enterprise or business is sold as small parcels of non-tradable shares. They are sold in return for pledges of money. The creator must produce the product for which they are raising capital. They must also create equity through the incorporation of a company. Equity crowdfunding, unlike donation and rewards-based crowdfunding, involves the offer of securities. These include the potential for a return on investment;
- Reward – where a reward, typically a product or service, is offered in return for a pledge of money towards a project. The funding does not rely on location of the creators of the projects and the funders / investors. Furthermore, funding increases as a project nears its goal. In reward-based crowdfunding, funders are often too hopeful about project returns. Often they must revise expectations when returns are not met; and
- Lending (Peer 2 Peer) – where a loan comprising of a collection of individual pledges is made available to a borrower in return for repayment of the loan with interest. In Peer 2 Peer crowdfunding, borrowers apply online for free. Following this, their application is reviewed and verified by an automated system. This system determines the borrower’s credit risk and interest rate. Investors buy securities in a fund which makes the loans to individual borrowers or bundles of borrowers. Investors make money from interest on the unsecured loans; the system operators make money by taking a percentage of the loan and a loan servicing fee.
We can advise on the advantages and disadvantages of crowdfunding. By way of overview, these are set out below:
Advantages of crowdfunding
- pitching a project or business through the online platform can be a valuable form of marketing and result in media attention;
- sharing your idea, you can often get feedback and expert guidance on how to improve it;
- crowdfunding is a good way to test the public’s reaction to your product/idea – if people are keen to invest it is a good sign that the your idea could work well in the market;
- investors can track your progress through crowdfunding – this may help you to promote your brand through their networks;
- ideas that may not appeal to conventional investors can often get financed more easily with crowdfunding;
- your investors can often become your most loyal customers through the financing process; and
- crowdfunding is an alternative finance option if you have struggled to get bank loans or traditional funding.
Disadvantages of crowdfunding
- crowdfunding will not necessarily be an easier process to go through compared to the more traditional ways of raising finance;
- if you don’t reach your funding target, any finance that has been pledged through crowdfunding will usually be returned to your investors and you may receive nothing;
- failed crowdfunding projects risk damage to the reputation of your business and people who have pledged money to you;
- if you haven’t protected your business idea with a patent or copyright, someone may see it on a crowdfunding site and steal your concept; and
- getting the rewards or returns wrong can mean giving away too much of the business to investors.
- While unsecured on the assets of the business, crowd-funders usually require personal security (guarantees) from business owners that invested money will be repaid.
Francis Wilks & Jones are experts in business matters. We can help you set up your business and provide clarification on alternative finance options.