Crowdfunding has brought different fundraising possibilities, particularly for Startups and small to medium-scale businesses. From reward-based to equity, debt, and donation-based crowdfunding, discover the ideal type of crowdfunding for your business.
???? Key Points
- Types of crowdfunding are reward-based (backers receive non-financial rewards), equity-based (investors receive ownership stakes), debt-based (borrowing with interest and repayment), and donation-based (contributions for charitable or personal causes).
- Choosing the right method depends on factors like funding requirements, target backers, legal considerations, costs, timeline, risk tolerance, and market validation.
What Is Crowdfunding? – Definition
Crowdfunding is the method of financing a Start-up company that involves getting a small amount of money from a larger number of individuals or groups of people.
In simple words “funds” from “crowd”.
Although there are alternative funding avenues available to startups such as Angel Investors, Venture Capital, and Bank Loans, let’s explore the types of crowdfunding that could benefit your business.
4 Types Of Crowdfunding
Basically, there are four types of crowdfunding. Let us know how each type of crowdfunding works with pros and cons.
- Equity
- Debt
- Reward
- Donation
Equity Crowdfunding
Equity Crowdfunding is a method of raising funds for a Startup company bringing the investor together that mutually benefits the business and investors.
That means investors contribute with the inflow of funds. While as a return they receive some ownership or equity stake in the business aligning the future growth and profits.
For an established company which is growth-focused, Equity Crowdfunding is a better suit, rather than opting for traditional business loans.
However, equity crowdfunding entails you pulling back, by giving up some control over your business. On the other side, the investor bears the risk of loss if the venture fails to achieve.
Pros Of Equity Crowdfunding
- Equity crowdfunding provides access to a diverse pool of global investors.
- It efficiently raises funds without traditional loan complications.
- Equity investors anticipate returns during exit events, like acquisitions or funding rounds.
Cons Of Equity Crowdfunding
- Loss of ownership control to the investors affects the decision-making process.
- Equity crowdfunding needs extensive time and effort for planning and execution.
- The equity method suits small to medium-sized firms seeking substantial capital for growth, but not for all business types.
Debt Crowdfunding
Debt crowdfunding, often referred to as crowdlending, is a method of borrowing and repaying funds.
In Debt Crowdfunding, Investors lend money to the company or project they wish to support. But in return, they will expect a repayment with interest on the borrowed amount over a predetermined time period.
It is a wise choice for businesses to choose debt crowdfunding that helps to secure funds and also retains ownership & equity. This approach is quite similar to bank loans, but multiple investors contribute instead of relying on a single source.
To secure a fund, entrepreneurs may need to provide collateral or guarantee by showing a track record of revenue generation. Some investors validate financial stability by checking the credit score of an individual.
Pros Of Debt Crowdfunding
- In debt crowdfunding, businesses keep complete control since investors don’t get equity shares or ownership.
- It works best for companies with a strong revenue history and makes it easy to get money from investors when compared to banks.
- Securities laws create a safe environment for both investors and entrepreneurs.
Cons Of Debt Crowdfunding
- Borrowed funds must be repaid, which can create financial obligations for the business.
- Some crowdlending agreements may require entrepreneurs to provide collateral or guarantees, which may risk losing your asset.
- A good credit score is a prerequisite for qualification limiting access to funds. In case of untimely repayment, it affects the credit score.
Reward Crowdfunding
Reward-based crowdfunding is a unique method of raising funds that do not include any equity shares or money return on investment.
Like other crowdfunding methods, reward-based crowdfunding investors provide financial support to the companies or projects they believe in. On the contrary, they are unlike other crowdfunding methods. Instead of ownership, stakes or interest, they receive non-monetary benefits from the company as return.
Rewards could be anything like
- Product
- Tshirts
- Gifts
- Event tickets
- Free Subscription
Low-cost projects or startups that look to build a Minimum Viable Product or test the idea usually go with Reward-based crowdfunding.
Parallelly, it is a cost-effective method to give rewards to the investors, thereby reducing the overall expenses, and avoiding being caught up in financial stress.
Pros Of Reward-Based Crowdfunding
- It provides a platform for startups to measure market interest and validate their product.
- Since rewards are typically non-monetary, the financial risk for companies is relatively low.
Cons Of Reward-Based Crowdfunding
- Reward crowdfunding may not generate substantial funds for large-scale projects.
- Sometimes it will be hard for Businesses to fulfil promises made to investors because it would cost more than expected.
Donation Crowdfunding
Donation crowdfunding is a method of raising funds where individuals and organizations contribute money to a cause without any financial returns or rewards.
Donors in crowdfunding are typically not considered as investors. They assist social entrepreneurs or non-profit organizations that run for social and environmental causes.
Running a successful campaign is not easy because the donors will contribute to a good cause with legal approval status, expecting nothing in return. Therefore it strongly demands trust and credibility.
Pros Of Donation-Based Crowdfunding
- People who support causes they care about without expecting financial returns bring a positive change.
- The process is easily accessible.
- Successful campaigns often build a sense of community among donors and organizers.
Cons Of Donation-Based Crowdfunding
- Given that, donors do not receive any financial gains or rewards, it is not meant for people who seek monetary benefits.
- Running a successful campaign requires an effective approach. Otherwise, it could misled by intermediaries.
How To Choose The Right Crowdfunding Type For Business
Let’s have a look at simple points to help you identify the right crowdfunding method for your business – factors to consider.
- Know Your Funding Needs: Assess how much capital your business requires for its goals, whether it’s a small project or a major expansion.
- Understand Your Investors: Identify your target backers or investors and their preferences, what they need as a return whether they are individuals, institutions, or the general public.
- Evaluate Legal Requirements: As rules can vary according to locations, try to understand the legal aspects of crowdfunding in your region or country.
- Cost Analysis: Determine the costs associated with running a crowdfunding campaign, including platform fees and rewards or equity distribution.
- Timeline: Decide on the campaign duration, as different crowdfunding methods may require varying time commitments.
- Risk Tolerance: Evaluate your risk tolerance and how comfortable you are with giving up equity or taking on debt.
- Market Validation: If you have a product or idea, assess if crowdfunding can help validate its market demand and appeal.
Frequently Asked Questions (FAQs) – Types Of Crowdfunding
What is Crowdfunding, and How Does It Work?
Crowdfunding is a method of raising capital by collecting small amounts of money from a large number of people, typically via online platforms. It works by presenting a project, idea, or business to potential backers who contribute funds to support it.
What are the Different Types of Crowdfunding?
The main types of crowdfunding are reward-based (backers receive non-financial rewards), equity-based (investors receive ownership stakes), debt-based (borrowing with interest and repayment), and donation-based (contributions for charitable or personal causes).
What Are Some Popular Crowdfunding Platforms for Each Type?
Some of the popular crowdfunding platforms for each type include Kickstarter and Indiegogo for reward-based, SeedInvest and Crowdcube for equity-based, Funding Circle and LendingClub for debt-based, and GoFundMe and Kickstarter for donation-based crowdfunding.
Bottomline
Crowdfunding comes in various forms, and each is suited to different funding purposes. Whether you’re launching a product, growing a business, or supporting a cause, knowing your crowdfunding options empowers you to turn your vision into reality.