Demystifying Crowdfunding…

13 March 2014

Until recently, financing a business typically meant asking a small group of investors to each commit sizeable sums of money. Crowd funding turns that model on its head by asking a large number of people to each invest a small amount of cash. It’s an interesting concept which has benefits all round – an opportunity for fledgling businesses to bypass banks in a bid to access finance and also chance for those with funds to spare to invest in exciting new ventures, at a level of risk that they determine. And crowd funding is not just for anonymous donors – it also gives friends and family of would be entrepreneurs a platform for investing in a project (or person) that they believe in.

February 2012 saw the first time a crowdfunded project raised over £1m – impetus enough for those of an entrepreneurial bent to kick start their venture. But before you invite the crowd into your kitchen, what do you need to know?

Types of crowdfunding

You may think that the term crowdfunding is universal, but there are actually multiple models, essentially falling into two camps; those that provide a financial return for backers and those that are more of an altruistic nature. Here’s the lowdown:

Donation Based Crowdfunding:.This is the most straightforward case, in which a contribution is made to a project or cause, and where the donor doesn’t receive anything in exchange other than a warm glow for supporting something in which they believe (and perhaps an opportunity to offset tax…!). This approach is most often deployed for charities, social enterprises, good causes and sometimes political campaigns, rather than for entrepreneurial endeavours.

Equity Based Crowdfunding: Equity crowdfunding allows businesses o raise capital by selling ownership stakes, thereby creating the opportunity for individuals to become shareholders and have a potential for financial return.

Debt Based Crowdfunding: Also known as peer-to-peer lending, investors are repaid for their investment over a period of time at a fixed rate of interest. Backers are attracted towards getting a return and in turn for the business, financing costs can be lower – plus it avoids the need for lengthy loan applications and bypasses the need for security (which for most banks these days is a deal breaker). Debt crowdfunding is usually most appropriate to existing businesses with some track record

Reward Based Crowfunding: Investors receive no financial return but are instead awarded a tangible “perk” in the form of an item or service as a thank you for their funds. In most cases, the reward will be the product that the entrepreneur is trying to launch – a clever way of getting the item to market, although it also works in the service sector where a company may offer a discount voucher for example. The big plus for the entrepreneur is that you don’t have to give away equity or repay the debt – plus you’ve gathered yourself a great audience for market feedback on your new invention!

Royalty Based Crowdfunding This mode offers backers a percentage of revenue from the venture once it is generating capital. Often a long game, as the project will need to get to market, and start generating income before

Crowdfunding fee models

As with the different models of crowdfunding, there are of course varying fee structures so its vital that you check the small print of any platform you are considering hosting your project with. Most reward-based platforms charge a success fee (in the region of 5%t) on funds raised, but be careful as some actually charge a higher rate) if you don’t reach your goal. The costs for using a debt, equity or royalty platform are more complex and can include numerous variables including creditworthiness, or a sliding fee structure based on the capital you are looking to raise. You’ll really need to do your homework on this front.

Where do I start looking?

Here’s our pick of the top 5 UK sites to consider:

• Kickstarter
• Funding Circle
• Zopa
• Crowdcube
• SyndicateRoom

For more information on this topic, ask for a copy of our April 2014 issue of iNsight which will feature the full article.