As the internet has become a safer and more palatable place to source and make investments, ‘crowdfunding’ has become substantially more popular. Many small companies and startups have looked to bypass traditional investment, going straight to their fans and customers to build a product or revive a forgotten IP.
As with any popular service or idea, though, this has prompted as many questions as answers. Some people still perceive crowdfunding as risky, and many more do not understand all of its forms, and the range of scenarios to which it can apply. Read below for a brief guide to what crowdfunding is, and the different types of crowdfunding you can use to source investments.
What is crowdfunding?
Where traditional investments involve a very limited number of parties contributing a large amount of money – individual investors or seed accelerators, for instance – most types of crowdfunding involve a larger number of backers making smaller contributions.
These are often collected as part of a public appeal, where a business uses a popular website platforms to pitch their idea, and offers up various benefits for investing. In some instances these are more akin to donations, with no divesting of control over the business.
The benefits might include a product that is being designed and manufactured, and other perks contingent on a certain level of investment, such as behind the scenes updates or merchandise. Fulfilling these perks requires extremely precise costing and planning, as well as transparency.
Depending on the scale of the project, the various types of crowdfunding may be used to fund it entirely; or as a demonstration of interest, in order to seek more substantial investments elsewhere. Some companies use crowdfunding to get started, while others return to it over several ventures.
What is equity-based crowdfunding?
For startups, this is arguably the most effective option, and an increasingly popular one. Sitting at the more traditional end of the crowdfunding spectrum, companies receive a source of early-stage private equity investment, and backers receive equity in the business proportional to their investment.
This retains many of the benefits of crowdfunding – a broad pool of global investors, distribution of risk, powerful platforms for creating pitches – but is more targeted towards serious investors. The money invested in equity-based projects can be higher due to the expectation of growth and gains, but this is not always the case.
Equity-based crowdfunding campaigns tend to be more pursuant of growth than other types of crowdfunding. While a donation-based crowdfunding campaign sells itself on the value of a singular product, service or idea, an equity-based campaign is a business proposition based on a more long-term roadmap.
The platforms and scope of equity-based crowdfunding vary significantly depending on your location. Countries such as the UK have fewer stipulations on who can invest in companies, leading to the development of platforms like Seedrs, where almost anyone can begin investing in companies. In the US, meanwhile, regulations mean that only accredited investors can use these crowdfunding platforms, with sites including AngelList and Fundable meeting these needs.
Equity-based crowdfunding campaigns are not immune to the issues of other forms of investment, such as donations failing to materialise; logistical issues with fulfilling rewards; or impatient backers. However, the reporting tools provided by equity investment platforms can allow businesses to paint a clearer picture of their finances than most donation based platforms.
Despite the difference between crowdfunding methods, the majority of equity-based campaign backers are first time investors. The demands in terms of reporting and demonstrating growth in equity-based campaigns are more substantial, as is the cost in relinquishing shares. But the investments tend to be more reliable and significant, and can have a much more meaningful effect in establishing your business for the long haul.
What is donation-based crowdfunding?
Donation-based crowdfunding may not be among the most well-known types of crowdfunding, but it is probably the most widely employed. It is most regularly used by individuals raising money for charity, such as when they are undertaking a marathon or similar event.
A donation-based campaign will seek funding with no expectation of reward (other than the satisfaction of giving, of course). Websites such as JustGiving and Crowdfunder are popular examples of platforms geared towards this type of crowdfunding.
A major advantage of taking donations without promising physical or digital rewards is monetary. As with any other sort of donation, these investments should be tax deductible, and potentially matched with schemes such as Gift Aid (though this will depend on the location and platform).
While this is a highly palatable and accessible option for charitable causes, it is less applicable to businesses pursuing a commercial project. After all, most people will not be willing to donate towards the realisation of a product or other venture without receiving something in return.
What is reward-based crowdfunding?
Reward-based crowdfunding is perhaps the most outwardly visible form of crowdfunding, and the one that often comes to mind when you mention the term. Examples of this form of crowdfunding would be Kickstarter, Indiegogo and Patreon.
Unlike other types of crowdfunding, investors in reward-based systems receive no financial incentive, but are rewarded with a perk. This could include receiving the product in question once it has been developed, as well as numerous other tiered rewards.
For example, an artist looking to print a book may offer a signed copy of the finished book for a $30 investment. For $10 they may offer a signed postcard, and for $150 they may offer a commissioned piece of artwork. These perks are often bundled together at higher buy-ins.
Different reward-based platforms tend to have specific stipulations. Indiegogo for instance offers ‘flexible goals’, where all the pledged money is retained, regardless of whether the campaign reaches its goal. Kickstarter and many others require that the set monetary goal is met, or the project ends in failure, with no donations received at all.
In the case of Patreon and similar platforms, this can be a particularly attractive means of running a creative business or other small enterprise. Instead of a one-off investment, backers pledge a monthly sum that allows a business to continue functioning. In return, the business or individual promises a regular feed of new content, such as podcasts, music or artwork.
This is a great way to fund a project without giving away any part of your business. It can also be invaluable from a marketing perspective, as a good reward-based campaign can be highly shareable, and lodge your business firmly in the public imagination.
It also carries additional risks, however. Fulfilling hundreds of physical rewards means a lengthy, expensive process of manufacturing and shipping that has claimed many campaigns before. Costs can easily escalate if not properly planned, with rewards dwarfing the cost of producing the actual product.
It can also be hard to get off the ground in the first place. The high standard of many other campaigns, the number of reward-based crowdfunders to date and the demands of keeping backers in the loop demand an extremely organised, creative and trustworthy team.
What is debt-based crowdfunding?
Often referred to as crowdlending or P2P (peer-to-peer) lending, this is the application of a familiar concept to online funding models: taking money that will then have to be paid back. Your investors are in fact lenders, who do not take any equity in the business. You will however be expected to pay them back on the completion of your project, plus interest.
This is much akin to taking a loan from a bank, but with smaller investments drawn from a wider pool of individuals. It is easier to sanction than a bank loan, and can raise similar amounts. This method carries a substantial amount of risk, as would be expected of any loan. Despite this, it appears to be gaining in popularity, with the market predicted to be worth £12bn by 2026.
Finding the right crowdfunding model for your business depends on your circumstances and goals. For more information on the various types of crowdfunding, the tax implications of a crowdfunding campaign, or expert advice on planning a successful one, feel free to get in touch.