about crowdfunding

What is crowdfunding and how can it help me?

In Business stuff by Rob Edsell

Our latest client is crowdfundingwebsites.co.uk (working on their Worx website as I type), a UK only resources site for both the investor and investee, focusing on UK based businesses.

We’ve loved chatting to Jonathan and his team about their business and found it all super interesting. We think you will too so here’s the low down:

What is crowdfunding?

Crowdfunding is an alternative way of financing projects and business ventures from many investors or funders (the crowd) through the internet.

Unlike traditional funding where organisations seek large sums from a few sources, such as angel investors, venture capitalists or business bank loans, crowdfunding raises varying amounts from a wide range of individuals.

Key players

Typically, crowdfunding will involve three participants: a business or campaigner looking to raise funds, the crowd of investors or lenders who could potentially fund it, and a crowdfunding platform; which acts as an intermediary between the crowd and the business.

Any organisation – small business, entrepreneur, property firm, rock band or charity – can launch a crowdfunding campaign using online platforms to connect to people who could help finance it.

Global phenomenon

Although crowdfunding is not a new concept, the internet and social media have helped it to prosper and grow dramatically. In 2014 the market grew 167% according to a 2015 report by Massolution; which collected data from 1,250 crowdfunding platforms (CFPs).

Business and entrepreneurship is the most popular category but crowdfunding isn’t solely about making money. It also enables profit and non-profit organisations to share an idea, generate publicity for it and gain market insights.

The three main crowdfunding platforms:

1. Debt or lending crowdfunding

A small company raises money through loans that are repaid with interest like a bank loan, except the lenders are many rather than one financial institution.

The peer-to-peer (p2p) debt crowdfunding model saw the most growth last year. Its advantages include the transparency of its pricing and its vetting.

The business doing the borrowing starts its campaign with an idea pitched on the p2p platform, which checks its creditworthiness. During this review period, it may also look at other criteria, such as minimum years’ trading and turnover.

When the campaign goes live, lenders have a good idea of the business’s background, credit rating, and exactly what they’re funding. They spread the risk by investing small amounts in lots of businesses.

Investors subscribe amounts on each campaign’s website usually until the maximum subscribers are reached or the loan is fully subscribed – each platform has different mechanisms.

The interest rate is decided on in different ways depending on the platform. Some use auctions where bidding continues until the lower interest rate bids win out over the higher. It’s good for the borrower because the rate is set at the lowest rate possible. On most platforms, the borrower sets the interest rate or the platform sets it against its own criteria.

Once the campaign is closed, the borrower enters into a loan agreement with the subscribing lenders.

Ideal for: established creditworthy businesses with a proven track record and investors who don’t want to risk loan repayments on very high-risk businesses.

Not ideal for: any business with no history or a low credit score, such as a high-risk start-up, or any business that can’t afford to repay the investor with interest.

Funding Circle is an example of a P2P lending site and is the world’s leading marketplace focused just on small businesses.

2. Investment or equity crowdfunding

Pools of potential investors – whether professional or ordinary members of the public – commit to invest in an emerging company in exchange for a stake in it, i.e. shares.

This model is relatively new and makes it easy for early-stage small businesses, start-ups and entrepreneurs to raise capital to expand their business cost-effectively and efficiently.

Given their lack of history and high-risk nature, these fledgling companies can struggle to access normal routes to finance, which in turn is a barrier to growth. In the past, only investors with deep pockets could afford to take on such risk.

Equity crowdfunding helps to solve both issues. It allows businesses to raise the funds they need for growth by tapping into backing they couldn’t normally get.

Investors don’t have to invest much to potentially earn a handsome return. By pledging small amounts on more than one business, the risks they take are smaller and they can diversify, which improves their chances of backing a winner in the long run.

The funding platform will do some vetting of the business before selecting it to pitch. The pitch tells investors how the borrower intends to use their funds and is designed to get their attention and build excitement. Attracted investors review the company and commit to invest in return for shares (think online Dragon’s Den).

The entrepreneur sets the terms, from the company’s valuation to number of shares offered and how many investors it seeks.

Ideal for: start-ups that want to grow but have no proof of trading or assets to secure a traditional loan – information usually required by financial institutions.

Not ideal for: entrepreneurs that do not want to give up any portion of ownership in their business or a say in its operation.

An example of an equity crowdfunding platform is Crowdcube.

3. Donation and rewards-based crowdfunding

The crowd that donates to charitable or personal causes does not expect a financial return but is investing for altruistic or philanthropic reasons.

A typical example would be someone fundraising for a charity bike ride using www.justgiving.com to collect small amounts from friends, family and work colleagues.

In contrast, the rewards model incentivises the crowd with non-financial perks such as pre-purchase goods or services. It is an increasingly common way for creative, media and entertainment projects to be funded.

Ideal for: individuals seeking a chance to tell their story, non-profit organisations trying to reach new donors, and companies keen to launch new products in a low risk environment and use pre-sales to fund a business launch.

Not ideal for: projects that don’t have the manufacturing and logistics resources set up to ship the promised goods or services on time, risking future sales and goodwill.

Kickstarter is the world’s largest funding platform for creative projects and Indiegogo is the largest global site for fundraisers.

Hybrid models

As well as these mainstays, there are also hybrid models, which combine lending and investment models, and are becoming increasingly popular.

You can read more about crowdfunding’s strengths and weaknesses here.

With thanks to Jonathan Littlewood and Neil Montgomery as the expert advice company crowdfundingwebsites.co.uk