Technology and the internet have played a vital role in the world of finance, especially in recent years. Online funding through crowdfunding enables individuals and businesses to gather funds for their projects, ventures, or even causes by collecting small financial contributions from a large pool of people. What started off as a sideline method for funding creative projects has evolved into a mainstream financing model not only for startups but also charities. This article explains the different types of financing models, what crowdfunding is and how it is changing traditional finance systems.
What Does Crowdfunding Mean?
Crowdfunding involves raising a certain amount of money by collecting small amounts of money from a large pool of people. This process is undertaken mostly through the internet. Different types of causes can be crowdfunded such as creative projects, new businesses, or even charitable causes. Crowdfunding gets most of its funds from the public and acts as a middle-man between the funders and entrepreneurs looking for resources.
The ability to access crowdfunding capital, unlike bank loans and other traditional financings such as venture capitals or angel investors, has made it appealing to many. Through crowdfunding, a creator can go straight to the community of supporters, also called backers, without going through intermediaries.
How does Crowdfunding Work?
The steps involved in crowdfunding are:
- Setup a Campaign A project is started by an individual, business or organization on a crowdfunding website. Following that, they provide a detailed description about the project, the monetary goal, and the intention behind raising funds. Most creators nowadays set a deadline within which they try to reach the funding goal.
- Promotion After going live with the campaign, the individual creator promotes it on social media, mailing lists, and other personal platforms. The funding milestones of an individual crowdfund campaign are reached predominantly over word of mouth and active social media presence.
- Contributions: Businesses and individuals, known as backers, support campaigns by donating money in return for equity, rewards, or even just the pleasure of helping a cause. In crowdfunding, contributors are given rewards in the form of products, services, or even mention depending on the type of crowdfunding.
- Reaching the Goal: The creator can access the funds raised for their project if the campaign meets or exceeds the funding goal. Some platforms may refund the contributors if the goal is not met; however, others allow the creator to keep the funds raised, regardless of the goal.
- Delivering on Promises: The available funds must be raised to successfully fulfil promises such as delivering products or providing updates about the project’s progress.
Types of Crowdfunding
Different types of crowdfunding exist to serve different purposes which include:
- Reward-Based Crowdfunding: A non-financial incentive, which may include the promised product or service, is given in lieu of payment via reward-based crowdfunding. This kind of crowdfunding is easily identifiable on Indiegogo and Kickstarter. For instance, backers are likely to fund the promotion of a new tech gadget and participate in its production so that they can receive an early version of it.
- Equity-Based Crowdfunding: In equity-based crowdfunding, backers support a business with capital and receive shares of the business as a payment in return. This enables most businesses, especially startups, to obtain funds in exchange for control of the business. This is accomplished through SeedInvest and Crowdcube, which specialize in this form of crowdfunding. It is ideal for businesses which need large amounts of capital but do not qualify for venture capital funding.
- Debt-Based Crowdfunding (Peer-to-Peer Lending): This model is also referred to as **peer-to-peer (P2P) lending) because it involves individuals lending money to other people or businesses with the expectation of being repaid with interest over time. This type of crowdfunding allows borrowers to obtain loans without traditional financial institutions, while lenders earn interest on their funds. (Lending) and Prosper are examples of platforms offering debt-based crowdfunding.
- Donation-Based Crowdfunding: This type is mostly associated with soliciting money for charity. Private individuals or groups raise funds to help social, humanitarian, or environmental projects. In this case, the donors give their money freely with no expectation of getting any monetary benefit. Platforms such as GoFundMe and JustGiving are well known for this type of crowdfunding, where people sponsor causes, such as aiding victims of medical emergencies or helping people overcome disasters.
- Real Estate Crowdfunding: Real estate crowdfunding enables investors to combine their resources to finance the development or purchase of a property. In return, investors are entitled to a share of the profits from the real estate investment. Some of the most popular real estate crowdfunding platforms are Fundrise and RealtyMogul.
How Crowdfunding is Changing Finance
The effect of Crowdfunding in the finance industry has been nothing short of revolutionary and prject it will only grow from here. Allow me to demonstrate how it has changed the financial world:
- Democratizing Access to Capital: As I have just mentioned, Crowdfunding has changed the landscape of Finance and one of the ways it has done so is via Capital access. Capital is available to the general public like never before. In the mainstream finance world, raising funds for a business required going through extremely complex procedures involving banks, venture capitalists, and angels. With Crowdfunding, everyone can raise funds publicly which neglected the need for complex pre-requisites.
- Changing the Investment Landscape: Using Crowdfunding platforms, owning a part in relatively new businesses with Equility Based Crowdfunding has never been easier. Instead of being exclusive to placebo investors of wealthy backgrounds, these platforms have made it accessible for the general population who can now buy and own shares from startups. This would mean that if the startups succeed, most would be cashing in on it. This has most certainly changed the scope of investing for the general public, especially with new startups.
- Lowering Barriers for Entrepreneurs: Entrepreneurs can now test their concepts without having to resort to traditional funding sources, thanks to crowdfunding. In certain instances, crowdfunding serves as primary validation for a business idea prior to attempting to scale it. If a campaign receives sufficient funds, it proves that there is a market need for the service or product, enabling the entrepreneurs to gain traction within the industry. This validation is often sufficient to attract other investors and partners.
- More Transparency: Every creator on crowdfunding platforms is required to have clearly defined goals, budgets, and timelines. This level of transparency fosters accountability and helps to build trust among creators and their backers. Given that projects are systematically public and supported by individual contributions, creators are incentivized to keep their backers updated.
- Fundraising for Social Causes: Donation-based crowdfunding has completely transformed how individuals and organizations raise money for charitable causes. Be it medical aides, disaster relief aids, or community-related projects, people can easily crowdfund and mobilize their networks to raise money for causes that matter to them. This has significantly sped up financial assistance for grassroots movements to gain momentum.
- The New Developed Business Models: Crowdfunding has helped in establishing new business models and approaches to doing business. Lifting the capital restrictions comes with several advantages and thus a lot of companies are seeking the attention of the general public to fund their businesses instead of waiting for banks and venture capitalists to do so. These innovations are resulting in new breeding businesses like crowdfunding platforms which increase competition for projects. Such businesses are changing how capital is distributed or flows in the economy and how the entrepreneurs strategize on funding.
The Risks Associated with Crowdfunding
Crowdfunding offers a lot of benefits, but it also comes with challenges. For the backers, there is a risk where the backing project could fail leading to loss of money. For the creators, the need to deliver on set commitments is sometimes too much and can hurt their reputation if they fall short. In addition, the realm of regulations governing crowdfunding is still a work in progress which poses some risks in terms of finances, economically, and legally for investors and creators.
Conclusion
The traditional methods of raising funds from people or companies has changed with crowdfunding. Funds can now be directly reached through the internet which has brought huge opportunities for investments, social funding, and new ideas. If crowdfunding further progresses it can expand business opportunities for investors and users incredibly. The fact that it comes with problems is undeniable as it has caused changes in the funding world, removing boundaries, and providing access to everyone regardless of their social status.