Glossary

Crowdfunding

Crowdfunding

Do you have a great business idea, but don't have the capital to get it off the ground? Or maybe you have a successful business model, but need a cash injection to take you to the next step? Whatever your business goals, crowdfunding is a great way for you to raise capital.

What is crowdfunding?

Crowdfunding is a great way for small businesses to raise money from investors - 'the crowd'. Unlike other forms of investment, crowdfund investors tend to invest small amounts of money in the business or project. This means that more investors are required.

There are many different types of crowdfunding, with some more beneficial to investors.

  • Loan-based crowdfunding: Known as peer-to-peer (P2P) lending. This is where an investor lends money to individuals or businesses in exchange for a set interest rate.
  • Investment-based crowdfunding or securities-based crowdfunding: An investor gets a stake in the company. This stake is often made up of shares and occasionally perks, like freebies or discounts on the company's products or services.
  • Donation-based crowdfunding: People give money and don't expect anything in return, usually to fundraise for a charitable cause or an individual in need. GoFundMe is perhaps the most well-known form of donation-based crowdfunding.
  • Reward-based crowdfunding: Encourage investment by rewarding people. If the business offers a product, those who invested may be 'rewarded' with access to the product.
  • Real estate crowdfunding: This specialised type of crowdfunding is designed for people who want to invest in property, but don't have the capital. When they then sell the property they've bought using the crowdfunding capital, they pay the investor back plus set interest.
  • Human capital crowdfunding: For people who need to raise money for their personal growth or projects, this type of funding give investors the opportunity to fund a project in exchange for a share of the winnings. This is often used for athletes and professional poker players.


How does crowdfunding work?

Crowdfunding is predominantly done online, whereas other forms of traditional fundraising and financing mostly occur offline. Typically, crowdfunding campaigns are an all-or-nothing funding model, which means if the target is met, you get the money and if you don't, all the investors get their money back.

Investors pledge an amount to a business or cause they like the sound of based on the presentation pack. There is a deadline for when the target amount is to be met and investors can see how the crowdfunding is progressing.

Investors can pledge money at any point throughout the campaign, as long as it's within the timeframe you've set. If you hit your target, the campaign will close, and the crowdfunding site you've used will take their cut from the amount raised.

It's worth noting that some forms of crowdfunding are classified as income and subject to tax, so that will have to be factored into your target too.

Do you pay back crowdfunding?

Whether you have to pay the crowdfunding back or not will depend on the type of funding. With reward-based and donation-based crowdfunding, you don't tend to, because people aren't necessarily investing with the intention of monetary return.

Loan-based crowdfunding means you usually pay the investors back plus set interest and those who put money in through investment-based crowdfunding will usually do so for a share in your company.

Why choose crowdfunding for business?

Many businesses choose crowdfunding as a form of investment for a number of reasons. The main one is that crowdfunding is a great way to raise capital quickly with no upfront fees, especially if you've struggled to get bank loans or traditional funding in the past.

If your business idea is unconventional, you may find that with crowdfunding you're able to reach a wider pool of people who are interested in what you're offering and are more willing to take a risk compared with conventional investors. 

Do you pay back crowdfunding?

Whether you have to pay the crowdfunding back or not will depend on the type of funding. With reward-based and donation-based crowdfunding, you don't tend to, because people aren't necessarily investing with the intention of monetary return.

Loan-based crowdfunding means you usually pay the investors back plus set interest and those who put money in through investment-based crowdfunding will usually do so for a share in your company.


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    What are crowdfunding advantages and disadvantages?

    Just like traditional forms of business finance, crowdfunding has its advantages and disadvantages.

    Advantages

    • It's a fast way to raise cash
    • A valuable tool for providing feedback on business proposals
    • Test the public's reaction to a product or service, without outlaying large amounts of money producing it
    • Investors can become loyal customers
    • A great alternative to traditional financing options

    Disadvantages

    • You might not be accepted onto your chosen crowdfunding platform
    • Even if you are accepted, your campaign may not be successful
    • If you have a failed campaign, it could impact the reputation of your business
    • If you get the rewards/shares wrong, you could end up giving away too much of your business to investors

    Before you decide on crowdfunding for your business you should consider the various types of business finance available and decide on the most suitable for your needs. 

    Who uses crowdfunding?

    Crowdfunding is predominantly used by start-up companies and growing businesses that are looking to take the next steps in their business growth. Whether they're looking to expand their premises or launch a new product, it offers companies and individuals the chance to source funding and also find like-minded individuals.

    It's not just start-ups who use crowdfunding, many non-profits, charities and social enterprises who need funds for a social cause use crowdfunding when traditional avenues of funding are unavailable.

    What can I use crowdfunding for?

    Crowdfunding can be used for just about anything, from funding your business to paying off debt. It can be used for research and development as well as fund educational endeavours such as a degree or course.

    What you will use the funds for can be broken down into commercial and non-commercial categories. Commercial projects include things like funding your business or product, buying a property or funding an innovative project. Commercial projects are usually loan or investment based.

    Non-commercial projects often include paying off debt, funding a charity, taking time for a passion project like writing a book. Non-commercial projects usually rely on backers or donations, and people aren't necessarily looking to get their investment back in monetary form. 


    What do investors get out of crowdfunding?

    For investors, crowdfunding is a great way to give back. Whether they're looking to support an entrepreneur or support a local cause. Crowdfunding investments also have the potential to offer higher returns than traditional investments.

    However, investors will usually only get their money back if the company goes public and is floated on the stock exchange[SD1] , is bought by another company and gets taken over, or if the management buys back your shares.

    Like any form of investing, crowdfunding has its risks, with no guarantees of ROI.

    Is crowdfunding regulated?

    The Financial Conduct Authority (FCA) authorises many crowdfunding platforms and there is an FCA register that lists all the authorised sites.

    In the UK, loan-based and investment-based crowdfunding is often FCA regulated, however, donation and reward-based crowdfunding are not; although certain payment services provided in connection with these types of funding projects are.

    Are there other commercial financing options?

    If you're unsure whether crowdfunding is the right solution for your business needs, we have a range of alternative funding solutions that could be what you've been looking for.

    We know that no two businesses are the same, which is why we tailor all our funding solutions to meet your exact needs. Whether you're starting up or you're looking to expand, we're here to help.

    Get in touch with us today for a no-obligation chat about how we can help you.


    BY Jessica Lambert

    27 January, 2022

    3MIN

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