Types of Crowdfunding for Startup Financing

Crowdfunding has taken off in recent years as a novel way to raise money for new or existing small businesses. There are many types of crowdfunding, but most work by attracting many small amounts from a large number of people, typically via Internet-based crowdfunding platforms. Many of the innovative inventions, technologies and other projects that have found business finance on popular crowdfunding websites would have been deemed too risky for traditional funding methods. The need for a non-traditional source of business funding for such projects is strong, and crowdfunding has filled this gap.

While crowdfunding has also been utilised for B2B commerce and for marketing existing businesses and products, a recent survey shows that only 2 percent of business owners have used a crowdfunding platform to finance their business. One of the most common reasons for not using crowdfunding is a lack of understanding about how it works.¹

Types of Crowdfunding

There are at least four distinct types of crowdfunding: reward, donation, equity and lending.² Each type has its own different set of risks and benefits for campaigns and their backers.

Rewards-Based

Today, the most common form of crowdfunding is rewards-based. These campaigns set various levels of rewards incentivizing backers to donate more money. For example, for a £10 donation a business may choose to include a backer’s name on the list of donors on its website. If a backer chooses to donate £100, they’ll be among the first people try out a new product. If they want to donate £1,000, they may receive a personal tour of the factory. It’s all up to the creator.

Donation-Based

Backers funding donation campaigns don’t seek anything in return. Though this type of crowdfunding can be used for business finance, it’s much more common for individuals with an immediate personal need, or charities supporting worthy causes.

Equity-Based

Equity crowdfunding allows backers to take an equity stake in a business. Several countries have recognized the value of equity crowdfunding as a new business financing source, and have introduced laws to regulate crowdfunding platforms.³ In the U.K., the Financial Conduct Authority (FCA) has set rules that equity crowdfunding platforms must follow in order to operate, including restrictions on marketing to consumers.^4,5

Looking to the future, equity crowdfunding has the potential to expand significantly. Equity investments that in the past may have been available only to a select group of investors, such as venture capitalists and private equity firms, could be open to a much wider group of people. Continued development of regulatory frameworks will provide investors with protections and companies with innovative ways to raise funds.

Lending

Unlike the crowdfunding types discussed above, money raised through lending crowdfunding is paid back in a set amount of time, with interest. Crowdfunding platforms provide investors with the opportunity to make money on a wide array of loans. Additionally, many lending crowdfunding platforms also serve as currency transfer platforms, so that lenders can execute foreign exchange when lending their currency to a recipient in a foreign country. In the U.K., the FCA regulates lending crowdfunding platforms, applying rules designed to ensure that firms meet minimum capital standards and clients’ money is protected.⁶

How Crowdfunding Can Help Businesses

Projects are started for a variety of reasons other than raising money. Crowdfunding is regularly cited as a way of getting direct feedback from the public about how to improve a new or existing idea.⁷This can save a business a great deal of money by testing for public demand before rolling out a product or providing a proof-of-concept.

Businesses also sometimes utilise a crowdfunding campaign as a marketing tool. Occasionally, crowdfunding campaigns go viral and are rapidly shared on social media outlets by millions of users. While there are some characteristics commonly shared by viral campaigns, like the fact that many feature a tabletop game or physical product, the phenomenon is generally unpredictable.⁸Carefully crafted campaigns featuring celebrities and expensively produced videos can flop while shockingly simple concepts become overnight sensations.

After the Business Funding Campaign

The benefits of a successfully funded campaign extend past the campaign’s formal end date. A successful campaign can provide proof of market demand that helps new ventures win further additional funding. Additionally, the sense of community built by passionate backers during the campaign remains as the funded enterprise grows.

 

The Takeaway:

The opportunity to take advantage of international crowdfunding is still being developed, but even now there are promising opportunities. There may always be a use for crowdfunding in a business. Crowdfunding campaigns have been utilised to provide marketing, proof-of-concept for new ideas, feedback from the public and even cut costs when dealing with a supplier.

 

Sources

1. “Small Business Owners Haven’t Caught the Crowdfunding Craze”, MarketWired; http://www.marketwired.com/press-release/small-business-owners-havent-caught-the-crowdfunding-craze-2003155.htm.
2. “Types of Crowdfunding”, Fundable; https://www.fundable.com/crowdfunding101/types-of-crowdfunding.
3. “The regulation of crowdfunding in Australia: where are we and what’s to come?”,Australian Banking and Finance Law Bulletin; http://m.minterellison.com/files/Uploads/Documents/Publications/Articles/Aus-banking-and-finance-law-bulletin_leigh-schulz-anddomenic-mollica_aug2015.pdf
4. A review of the regulatory regime for crowdfunding and the promotion of on-readily realisable securities by other media, Financial Conduct Authority; https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
5. “The Current State of Australian Crowdfunding Regulation”, LegalVision; https://legalvision.com.au/the-current-state-of-australian-crowdfunding-regulation/
6. A review of the regulatory regime for crowdfunding and the promotion of on-readily realisable securities by other media, Financial Conduct Authority; https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
7. “6 Ways to Use Crowdfunding for Product Development”, Entrepreneur; https://www.entrepreneur.com/article/247668
8. “Things Almost Every Viral Kickstarter Has in Common”, PC World; http://www.pcworld.com/article/2924327/web-social/6-things-almost-every-viral-kickstarter-has-in-common.html