Make the most of the support from the crowd
What to look out for
- Red Individuals and organisations must deliver on what their crowdfunding campaign promises investors
- Amber Crowdfunding taps into a wide network of people who can donate a relatively small amount of money
- Green Early-stage businesses looking to grow may offer investors a stake in the business in return for their investment
The growth of crowdfunding for businesses has been a real boost for those entrepreneurs who have a dream to go it alone but are struggling to raise the finance needed. Read on to find out more.
Why would you use crowdfunding?
If you want to start or buy a business or you have a new project you want to undertake but don’t have the necessary funds, crowdfunding can help.
Alternatively, you may want to make a hobby into something more. For example, a writer and artist may have a graphic novel they want to produce, or an independent filmmaker may need help with production costs.
Social lending, or microfinance, is another type of crowdfunding. People secure loans to help them with various things – such as funding a serious operation or to buy raw materials to start a business or social enterprise.
How does crowdfunding work?
Crowdfunding taps into a wide network of people who can donate a relatively small amount of money individually. It enables the pool of investors to expand beyond relatives, owners and venture capitalists to numerous individual investors. In other words: The ‘crowd’.
There are three broad categories of crowdfunding: reward-based, equity and social.
With reward-based crowdfunding, individuals or businesses pitch to investors via a crowdfunding platform. The pitch can involve investors participating in the launch of a new product or receiving a gift for their investment.
For example, investors could receive special editions of the graphic novel they funded or have their name printed in the finished product.
The best-known reward-based crowdfunding platforms allow investors to view campaigns looking for funding and select any they wish.
Some only provide access to funds once a funding goal is reached, while others offer a flexible model in which funds can be accessed before the funding goal is reached. Either way, the individuals and organisations must deliver on what their campaign promises investors.
Early-stage businesses looking to grow may use equity crowdfunding, in which investors acquire a stake in the business in return for their investment. If the business succeeds, investors could see the value of their stake increase.
Unlike rewards-based platforms, equity crowdfunding platforms require businesses to provide information about their operations and finances.
If a business fails, shares issued via equity crowdfunding are worthless. Investors are not repaid. This is the risk investors take on. They may also find it difficult to sell any shares they have in crowdfunded businesses.
It’s worth noting that equity crowdfunding differs from peer-to-peer lending on platforms where lenders loan money to businesses in return for a fixed return over a certain period.
Social-lending platforms allow individuals to lend funds which the borrower repays when they can, for example, when a project generates income. Investors can then re-lend the money.
What are the costs of crowdfunding?
There are various platform charging methods. Some don’t charge interest against crowdfunding loans but take a small cut of the funds raised. Others, for example, may charge a five per cent platform fee on the funds raised, while payment processors apply a three to five per cent charge on donations.
For equity funding, one example may well be the charge a success fee of seven per cent (excluding VAT) of the amount raised. There is also a completion fee which is on average 0.75-1.25 per cent of all funds raised, which includes third party costs on each payment, which range from 0.47 per cent to 2.9 per cent.
Alternatively, there are examples of platforms not collecting interest itself, but most borrowers pay interest to local field partners to cover costs. An online fundraising platform may charge a five per cent fee on each donation made through the site, which could be taken from the Gift Aid portion of donation. Others may only charge a standard payment processing fee.
How long does it take to secure crowdfunding?
Depending on the nature of the funding, once the borrower has registered on the crowdfunding platform and issued the appeal for funds, it could be a matter of hours or days for the required amount to be raised. One platform suggests the average time for successful campaigns to hit target is 22 days.
The faster campaigns tend to be those that have attracted media interest. Larger funding targets, or those that aren’t well-publicised or don’t offer attractive rewards will take longer. Some crowdfunding campaigns never reach their target amount.
What type of security do I need for crowdfunding?
For reward-based platforms, no security is needed other than borrowers delivering what they promise investors, whether that’s repaying the funds or providing a reward or a stake in the business. Equity crowd-funding provides investors with their equity stake in the company and may also have to comply with regulatory requirements.