In the last few years, crowdfunding has become increasingly popular due to its simplicity, and accessibility. It’s been used to fund a series of projects, spanning business and personal interests, and more recently, it’s become a more common form of finance for businesses.
Crowdfunding works by giving both private individuals and investors the chance to contribute small amounts of money towards a project or business. If enough people contribute, your funding round can be oversubscribed and you can choose whether to increase the size of the round or reduce investors accordingly. It has evolved where larger institutions are also investing through these.
Crowdfunding won’t work in every instance, so it’s essential to understand how it works and determine whether it’s a match for your business. It’s also important to know that crowdfunding can come in many forms, so you need to identify one that works for both you and your funders.
Below, we delve into the various types of crowdfunding and how they work so that you can select the right approach for your business financing.
- Equity crowdfunding
- Peer-to-peer lending
- Donation-based
- Rewards-based
- Profit-sharing
- Which one is right for me?
Equity crowdfunding
With equity crowdfunding, people will contribute money towards your business in exchange for shares. It works similarly to holding shares in a company on the stock exchange would work, although liquidity of shares is much less, meaning it is harder to sell your shares unless there is a willing buyer or the business is sold.
This type of crowdfunding tends to happen in early-stage ventures that are unlisted. Commonly, potential investors will find opportunities through a crowdfunding platform and choose to place their money into it. As the business grows, their share value may increase – but equally, it could decrease, which is a risk the investors will have to take. They’ll also need to accept it may take some time to see a reasonable return on investment, so patience is required.
If you are pursuing this option for your business, it’s vital to find a reputable platform to attract funders. Established examples include Crowdcube and Seedrs. As with any other type of investor pitch, you’ll need to make a convincing proposal and showcase your entrepreneurial idea in a favourable light to secure substantial funding.
Peer-to-peer lending
Although it falls slightly outside of the ‘crowdfunding’ umbrella, peer-to-peer lending works similarly. The main difference is that, rather than offering equity in your business, the money will be raised as a loan across multiple lenders. You will then need to agree and stick to a repayment schedule.
The people who contribute to your loan will profit through interest earned on their money. It also tends to be more risk-averse than equity crowdfunding, as the lenders will receive their money back in some form (even if it means resorting to debt recovery) as most loans are backed by personal guarantees from the directors of the business.
For a business, it can be easier and quicker to obtain than a traditional bank loan, but it will be more expensive. If you have assets to use as collateral, it can lower the interest rate and assure lenders.
Before committing, you should make sure you are comfortable with your repayment schedule.
Donation-based
As the name suggests, donation-based crowdfunding sees people donate money for your business, often through platforms like JustGiving. There is no requirement for you to repay them.
As you rely on people’s charity, there are only specific circumstances where donation-based crowdfunding will work. Examples include if your business is serving the greater good in some way (such as being sustainable or tackling poverty), having a local impact, or having undergone some sort of struggle that people may want to help you out of.
If you are pursuing this route, you will likely need to rely on word-of-mouth, press coverage or social media to get the word out about your plight and encourage people to donate to you so you can amass the funds you need. However, when it works, it can be hugely beneficial for eligible businesses.
Rewards-based
Rewards-based crowdfunding is like donation-based in that people will give you their money without expecting repayment or equity. However, you will offer them some sort of reward in exchange for their contribution, which could include exclusive products, deals, freebies or content.
When utilising rewards-based crowdfunding, your business needs to interest people enough that they will pay for a reward. For this reason, it often works well if you have a niche target audience.
A famous example is the American TV show Veronica Mars, which crowdfunded the budget for a movie to be made. Contributors received free merchandise and exclusive content from the stars. Upon completion, the campaign had raised over $5 million and became one of Kickstarter’s highest-earning projects.
If you find the right niche and offer attractive incentives, rewards-based crowdfunding can enable you to raise decent amounts for your business. It’s also a great way to engage your audience base from early on, with the hope that they’ll become loyal customers once you reach your goals.
Profit-sharing
Finally, we have profit-sharing crowdfunding. Unlike peer-to-peer lending or equity crowdfunding, there isn’t a set repayment schedule about how investors will get their money. However, you agree to share any profits you make with your contributors (the level at which can be negotiated).
It relies on you being able to profit. There won’t be a requirement for you to repay those who have provided funding if you don’t. However, it does mean that your contributors will be left out of pocket.
Alternatively, if you generate a profit, you will need to be prepared to split this with others rather than solely retaining it for your business.
To have any chance of success, you’ll need to be able to convince people of your profitability. However, this is one of the rarer and newer forms of crowdfunding, so it can be hard to find any platforms currently offering it.
Which one is right for me?
The right option for your business will largely depend on your preferences and offering.
As we’ve mentioned, certain types – such as donation and rewards-based – require your business to tick specific boxes to stand a chance of engaging funders and encouraging them to part with their money. In these instances, you need to reasonably ask whether your business fits the criteria to be able to generate finance.
The next question to ask is whether you prefer debt or equity financing. If you feel more comfortable with a loan and believe you can meet a repayment schedule, peer-to-peer lending is likely the solution for you. If you would rather offer out shares and spend time generating a return on investment for stakeholders, then equity crowdfunding is your best bet.
If neither of those jumps out to you, it might be worth considering profit-sharing crowdfunding to ease the repayment requirement – but you need to be happy to part with your profit at the end of the day.
Spend time researching the different types of crowdfunding to determine which is the best fit. Looking at examples of other businesses that have utilised crowdfunding can also help you to imagine what’s possible for you – especially if you have competitors who have successfully used it.
It might also be worth discussing the options with a financial advisor to get an independent perspective.
If you aren’t sure if crowdfunding is for you at all, remember that other solutions may suit you better.
Conclusion
Crowdfunding can be a useful financing tool for many businesses. However, to succeed, it’s vital to understand the different types of crowdfunding in the market and find one that suits you.
By identifying the best option, you can secure the finance you need via an alternative route, which is beneficial if you’ve struggled to access traditional funding. You can also build up a bank of supporters, which can stay with your business long-term and help you reach your goals.
If you want to find out more about crowdfunding and the various options that fall under it, get in touch with one of our advisors today. We can discuss your needs to determine the right path for your business, as well as alternatives that may work.
We can also help you craft an enticing proposal on behalf of your venture, which can be uploaded to crowdfunding platforms to attract funders.