In recent years technology has allowed new financing methods to arise outside of traditional financial markets. These include online funding platforms that make peer2peer lending in the form of equity, debt and reward-based crowdfunding possible. Peer2peer lending refers to finance provided through direct lending: savings are invested directly into projects rather than deposited with a bank who then invests the funds at their own risk.
This article aims to explain the three different approaches to crowdfunding, their differences and their similarities.
In the case of Equity Crowdfunding, a pool of high net individuals and/or venture capital firms invests in a start-up or an SME.
In return they receive shares in the young company; the entrepreneurs give up a part of the ownership to receive financing.
As investors usually require to see some first achievements of the start-up, this type of finance is normally used for more developed projects or already existent small companies. Furthermore, entrepreneurs have to be willing to give up a share of their company to use this type of finance.
The advantage of equity crowdfunding is that the young company is not required to pay interest which is especially helpful when the company is not making significant profits yet. Moreover, investors can help with business decisions and networking to grow the company faster.
The online estate agency eMoov is a good example of a successful crowdfunding equity issue. They managed to secure £2.6m through Crowdcube from a diverse investor base of 795 investors including renowned venture capital firms.
Crowdcube and Indiegogo are the most famous equity crowdfunding websites, have a look at their websites to get a feel for what equity crowdfunding is all about.
Small and medium-sized businesses can receive loans through Crowdlending. The funds are provided by individuals and/or other businesses who receive interest on their investment. However, the investment is usually not insured so in case of default, investors carry all losses.
Crowdlending is often used by companies that are looking for debt financing but were rejected by traditional banks, so risk and return are normally high.
The leading crowdlending platform for businesses is Funding Circle.
It was the first UK site to use the process of peer-to-peer lending for business funding allowing individuals and organisations to directly lend to small businesses.
Reward-based Crowdfunding is all about making new products or projects possible. Many individuals donate a small amount of money to a project, product or idea that they find inspiring. They usually receive some form of reward for their investment, often but not always, the return is the item produced by the start-up. Investors also usually get to follow the project’s progress over time getting inside views on the creative processes and developments.
This type of funding is typically used for very innovative projects that are currently in the proposal stage. Therefore, products have to be original so that they catch investors’ eyes and stand out when competing with other projects for the funding available.
Kano, the british start-up that offers DIY computer kits for kids is a perfect example of a company that was able to successfully recieve finance through reward-based crowdfunding. The company raised $1.5 on Kickstarter in addition to its investors’ funding.
Kickstarter is considered by many the Number1 reward-based crowdfunding platform so if you’re looking to use this kind of finance for your business, KickStarter is a great place to start.