Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money. Traditionally, financing a business, project or venture involved asking a few people for large sums of money. Crowdfunding switches this idea around, using the internet to talk to thousands – if not millions – of potential funders. Typically, those seeking funds will set up a profile of their project on a website such as those run by our members. They can then use social media, alongside traditional networks of friends, family and work acquaintances, to raise money. Below is a brief description of each of the different type of crowdfunding.
Donation / Reward Crowdfunding
People invest simply because they believe in the cause. Rewards can be offered (often called reward crowdfunding), such as acknowledgements on an album cover, tickets to an event, regular news updates, free gifts and so on. Returns are considered intangible. Donors have a social or personal motivation for putting their money in and expect nothing back, except perhaps to feel good about helping the project.
Investors receive their money back with interest. Also called Peer-to-Peer (p2p) lending, it allows for the lending of money while bypassing traditional banks. Returns are financial, but investors also have the benefit of having contributed to the success of an idea they believe in. In the case of microfinance, where very small sums of money are leant to the very poor, most often in developing countries, no interest is paid on the loan and the lender is rewarded by doing social good.
People invest in an opportunity in exchange for equity. Money is exchanged for a shares, or a small stake in the business, project or venture. As with other types of shares, apart from community shares, if it is successful the value goes up. If not, the value goes down.
A Little Bit Of History
The first online crowdfunded project is thought to have occurred in 1997. Rock band Marillion were unable to afford to tour after the release of their seventh album so American fans used the then fledgling internet to raise $60,000 so they could play in the US. Although the band wasn’t involved in the first round of fundraising, they have since used the same techniques to successfully fund the production of their following three albums. Since then, this marketplace has grown substantially.
So to recap…
- In rewards-based crowdfunding, backers give a small amount of money in exchange for a reward.
- In donation-based crowdfunding, donors donate a small amount of money in exchange for gratitude and the feeling of supporting a cause they believe in.
- In equity crowdfunding, investors invest large amounts of money in a company in exchange for a small piece of equity in the company.
- And in debt crowdfunding, lenders make a loan with the expectation to make back their principal plus interest.