Startup entrepreneur tips

What’s the first thing you need to know about Crowdfunding?

What has been the driving force behind the rise of social media has been the power of the crowd to express satisfaction or dissatisfaction about something by using technology to broadcast messages instantly to anyone willing to listen.

On-line marketplaces such as Kiiji (open market trading), OpenTable (restaurant reservations), Match.com (dating), Ebay and Amazon (products) have eliminated inefficiencies in connecting buyers and sellers by making transactions more accessible through the use of technology. 

 Not surprising then, the power of the crowd and on-line technology have been the drivers in launching a new way of raising money - Crowdfunding. As defined by Forbes, Crowdfunding is “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet”. And this is the topic of the next series of blog articles that I will write for you.

With Crowdfunding Platforms (CFP) supporting the raise of an estimated $2.78 billion in project funding in 2012 and forecasted to generate $5.18 billion worldwide in 2013, the sector is particularly strong, boasting double or triple digit growth rates.

With such favorable fundamentals, Crowdfunding just shouldn’t be ignored.  

For those of you not familiar with this rather unique way of micro-financing; let me start with a quick definition and then describe the types of Crowdfunding models in operation today.  There seems to be a lot of confusion about the differences and it’s important to have a good starting point to get at the right facts as a foundation.

Crowdfunding refers to an exchange between a person and/or a company (initiator) that has an idea, project, social/political cause or product prototype and for which they are looking for funding support from third parties (backers/crowd). Crowdfunding is the means by which small contributions are collected from many parties in the crowd so the initiator can reach a specific funding goal. Sometimes the contribution amounts are very small $5 and some can scale to $1000’s of dollars depending on the project.

All parties in this marketplace use on-line Crowdfunding technology platforms to broker these transactions. These platforms have been developed by companies that handle the exchange. Examples are Kickstarter, Indiegogo, RocketHub, CrowdCube, Kiva, FundRazr, CircleUp and hundreds of other sites that have been developed since the Crowdfunding concept got its start in 2005.

Now, here is where the confusion arises with regard to Crowdfunding and its opportunity.

There are essentially four types of Crowdfunding models in the market today. They are very distinct in terms of profiles, risk orientation and regulatory limitations. So if someone talks about Crowdfunding you must seek clarification on what type of model they are referring to because there are important distinctions to consider of each.

Here are the four types.    

Donation based Crowdfunding is philanthropic or sponsorship oriented which is very much commonly recognized. If there is a cause, event or charity a donation is provided by a backer and there is no expectation of compensation or financial return other than the satisfaction of contributing. Well, OK, there might be a tax receipt issued and a financial benefit (Smile).

Reward based Crowdfunding involves the exchange of non-monetary rewards such as gift or the opportunity to pre-purchase the initiators product or service. The backer does not expect a financial benefit in return for his or her financial contribution. These backers are fans or evangelists of the initiators project. This type of Crowdfunding has been the most popular and widely used by entrepreneurs from artists, musicians, film producers to designers of products.

Lender based Crowdfunding is based on advancing a loan to an initiator with the expectation that it is paid back in regular installments which include the original principal investment. Examples of some sites are LendingClub.com and Prosper.com. This is the least popular of the models.

All three of the Crowdfunding types mentioned above are legally employed. The following model is not.

Equity based Crowdfunding is the model where funders receive an interest in the company in the form of equity or shares and may also share in revenue or profit-sharing arrangements. This type of Crowdfunding is being touted as a new phenomenon that will put the current traditional equity funding mechanism such as Angel investment on its head. But, the problem right now is that the various Securities Commissions have yet to approve its use and therefore this type of Crowdfunding is illegal in various jurisdictions.

For example, equity-based Crowdfunding is widely legalized in several countries in Europe, as well as Australia, but not yet in Canada. And although the United States, through the Jobs Act, is working toward a legalized standard for equity Crowdfunding the regulators are slow in implementing a functional law and by that I mean rules employed to implement it into law. The SEC, which is already late with its submission, will probably continue to delay for the unforeseen future. Equity Crowdfunding on ice!  

You can now appreciate why Crowdfunding is often referred to as the democratization of funding. It allows a greater opportunity for anyone to fund a project and participate in turning dreams into reality.

You now know the different types of Crowdfunding models. Why is this important? Because knowing the varying types will allow you to assess if one of these models is the right fund raising channel for you.  

Crowdfunding has several advantages and disadvantages. I’ll cover these in my next post entitled – “Crowdfunding – Is it right for you?”