Crowdfunding operates on the principle of asking a large number of people for small investments usually for some form of project or venture. Historically the opposite applied whereby a small group of wealthy, singular investors held the keys to financing. However, the rise of the internet and a global community has made crowdfunding a viable and accessible means to raise finance needed for your enterprise.
In this post I look at the different types of crowd funding, what they entail and some of the success stories that have emerged from this new, alternative source of finance to bank lending. There are four key types of crowdfunding: donation, rewards, equity and debt. The key point here is the same principle of crowd investment applies in each case, with the differences arising from the kinds of incentives on offer.
Donation applies to instances where there is no material reward for an investor’s aid. The incentive here is charity and philanthropy. A recent example was the case of an elderly gentleman called Alan Barnes who was assaulted and broke his collar bone. The subsequent community fundraising on GoFundMe via the Alan Barnes Fund page generated so much cash (£329k) above the original target (£500) that that they had to stop the donations. The result was the funds were then used to re-home him.
Rewards covers crowdfunding projects that offer products or services in return for an investor’s support. These rewards usually vary depending on the size of the investment made and the company in question. A typical example being a business that has developed a product but not yet fully launched, then an investor may receive a prototype model of the product, or exclusive member benefits.
Take Oculus, they used the Kickstarter platform to raise money for the Oculus Rift virtual reality headset. They crowdfunded almost $2.5m from nearly 10,000 donors which made it one of the most successful rewards-based Crowdfunding campaigns in history. Donors who contributed smaller sums received posters and T-shirts while those who provided larger donations enjoyed a developer kit for game developers. The company subsequently sold to Facebook for $2bn in 2014.
Equity crowdfunding is where investors receive equity or company ownership in return for their contribution. With equity crowdfunding the expectation is that investors will receive a dividend payment or appreciation on their investment. A great example we came across was when Corrado Accardi used Crowdcube to raise £440k and launch his Pizza Rossa concept after approaches to banks and investors had ended in disappointment.
Debt crowdfunding (or loan crowdfunding) is the first type of investment crowdfunding which allows businesses to borrow money from a group of people rather than a bank. With debt crowdfunding investors lend money to a company and receive interest from their investment. Ideally businesses are able to get funded at lower interest rates. Quite simply, debt crowdfunding functions as a quick and easy business loan, yet companies pay interest directly to their investors rather than to a bank.
We do a lot of work with Funding Circle, a crowdfunding platform specifically geared towards business funding (see above). Securing finance in today’s business environment is a challenge for many owners. Banks do not always offer suitable packages or their terms and conditions might not be appropriate. Crowdfunding represents an alternative finance market by opening a business to investment, enabling potential investors to bid and offer the funds for a loan.
The idea behind Funding Circle is simple: to apply the fundamental principles of crowdsourcing to business finance. Their global success is a testament to the number of businesses and investors who have benefited from Funding Circle’s services, making them the world’s leading market for small businesses. You can also find out more about crowdfunding (Funding Circle) as a viable business financing option in this article, Crowdfunding: a great business loan option.
Based near Oxford, NGI Finance has helped businesses across the UK secure over £100m worth of funding since its inception.
The content of this post is up to date and relevant as at 16/03/2015.
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