Not too long ago the best ways to raise funds or money for a project were to take a loan, try to work and save enough, ask family and friends, or search a small pool of wealthy investors for someone who might be interested.
It was certainly difficult using any of these methods, which is why when crowdfunding gained recognition, most people were glad to dive into those investment opportunities.
Despite how popular crowdfunding has become, it’s still not a great choice for everyone. Today we’ll discuss the definition, advantages and disadvantages of crowdfunding for investors and project creators alike.
What is crowdfunding and how does it work?
As you might already know, crowdfunding is when several people come together to provide the capital to get a project off the ground. In other words, a ‘crowd’ funds a project or business rather than taking loans or grants from few sources.
How it works is that an individual, group or company creates a campaign that is like a pitch, on crowdfunding platforms or a crowdfunding website.
Several potential investors who can contribute to the project or business idea can then see these crowdfunding campaigns. There are lots of crowdfunding websites or platforms specifically designed to help people do this.
Types of crowdfunding
There are different types of crowdfunding that help to further streamline your goals and results. They include;
Reward-based crowdfunding
This type of crowdfunding is exactly what it sounds like. Here contributors are referred to as backers who finance your ideas for a reward. For example, if it is a business venture you can offer backers a reward that is the product or service the company offers or just items that would come out from completing the project with the donated funds. The backers don’t expect any monetary returns.
Donation-based crowdfunding
While similar to reward-based crowdfunding, the donation type is when someone donates to a cause. This type is common for helping charities, non-profits, disaster relief or even personal needs like medical bills. Most times, the backers expect nothing in return except otherwise stated in the campaign.
Equity-based crowdfunding
This type is common for businesses, a company or individuals launching an idea, raising capital for a venture, and so on. In equity crowdfunding, investors finance an investment. They become equity owners or shareholders in the business. The size of the share depends on how much an investor contributes. They receive returns for their investment.
Peer-to-peer crowdfunding
Unlike other types of crowdfunding, peer-to-peer is the closest to the traditional ways of raising funds. It is where people crowdfund ideas as a loan to be repaid with interest. Peer-to-peer offers the benefit of leaving you as the sole owner of your business. But the loan must be repaid with the corresponding interests by a certain deadline.
Crowdfunding advantages
Creating a campaign and seeing it through takes a lot of effort. Both new and established brands benefit from the opportunity to raise awareness for their businesses via marketing and media, acquire feedback, test products and even meet potential brand ambassadors. They can set funding goals and meet or exceed them with the help of those willing to finance projects.
Setting up campaigns is mostly free, although some websites may charge fees on the money raised. For investors, the benefits are similar as well as varied.
Crowdfunding advantages for an investor
It helps to diversify your portfolio
As an investor, diversifying your portfolio is one of the most important strategies. Not only does it help with reducing risks, but it also helps to increase the reward. Crowdfunding helps you diversify your portfolio by investing with various companies. Since there will be other investors involved, you can afford to spread your investments.
Higher potential for success
Financing isn’t where it ends with crowdfunding. It’s also important that the creators have a successful campaign. The good news is, crowdfunding campaigns have a high potential for success. Crowdfunding isn’t linked to other financial sectors that economic instability could affect.
The fundraising process for startups and any business venture is also made completely transparent with valuable information released, so you can decide what works for you and stay updated through the project.
Great for angel investors or beginners
This model is ideal for any kind of investor but especially favors angel investors and beginners. It provides an easy start where experience, connections, network, and other factors are not so influential in your investment success. All crowdfunding campaigns are accessible to anyone with a clear indication of how much capital is needed and the probability of a successful campaign.
You can start anywhere
One of the top advantages of this investment model is you can start with any amount of money. Regardless of how much you have, there are always opportunities to invest.
On crowdfunding platforms, you find that campaigns have various minimum limits which differ depending on the business idea or concept. So you can pay as low as $10 to support a business you like. Or as low as $1000.
You can show your support for innovative startups
We have all seen it happen repeatedly – how innovative startups die before they can be realized due to lack of support.
Crowdfunding allows you to support a new or established brand with innovative ideas. The concept helps entrepreneurs test, gather customers, and even gain feedback. It also provides a community of like-minded people where you can get easy access to advice, guidance, and a promising network.
Crowdfunding disadvantages
Despite how wonderful it may seem, there are enough cons of crowdfunding. These disadvantages make this funding method unsuitable for some companies and investors.
Successful campaigns must reach their target
On most crowdfunding platforms it’s a rule that a campaign must reach its funding goal to be deemed successful and for the money to be released to the creators. It’s quite common among crowdfunding websites and can mean a waste of effort for the brand. Investors have little to worry about in this area except for disappointment, as the money will be returned to you.
Failed projects can harm your reputation
Because of the exposure campaigns get with marketing and media, failure can be devastating. For a company or startup, it sends a wrong impression to investors. And sometimes the damage to reputation spills over to certain investors.
It’s not a one size fits all method
Not all business ideas can work well with crowdfunding. This means as an investor you might not be spoilt for choice and as a creator, you won’t be able to get the support, traction, or other benefits needed for the idea to be realized.
Lack of control
Regardless of the type of crowdfunding you choose to invest in, you have limited control over the investment. The company will make all decisions that affect rewards or returns.
Even as a creator or company, you have limited control and ownership with crowdfunding types like equity.
Idea theft
It won’t be the first time a business idea has been stolen. Crowdfunding your idea puts it plainly out there for all to see. This attracts copycats and thefts especially if the campaign is unsuccessful. Leaking valuable information about a product is also another risk that could hurt the business. Because of the transparency required, other businesses can easily find all they needed to copy products and services. These disadvantages are almost inevitable.
Scams are likely
It’s important to never forget the existence of scams in any business or financial venture. Crowdfunding platforms are not an exception although the website themselves work hard to eliminate such. It’s important to do proper checks as an investor before you finance any project.
Failed campaigns can mean losing your investment
There’s no guarantee projects will go through. A successful crowdfunding campaign doesn’t mean a successful investment. Losses and failures can occur that could mean losing your capital.
Platform fees
All crowdfunding platforms take a percentage of the total amount. Fees that may apply when you crowdfund include payment processing, pledge fees, hidden charges for example with credit card companies, and so on. All parties should always put possible fees into consideration.
Risks associated with crowdfunding
A creator is at risk of a project not succeeding or reaching the funding goal. But for an investor, risks can include-
- Business failure
- Difficulty selling shares since they are unlisted
- The crowdfunding website may get hacked or compromised before the investment is paid out to the companies.
- Returns on investments are not guaranteed if the shares don’t rise in value or they do not make profits
Before you choose to crowdfund
If you’ve decided that this method works for you to finance an idea of a project, you can get started by finding the ideal platform to use. Most are free. Take the time to build awareness and a campaign for successful crowdfunding. Use the community for your crowdfunding campaign to gather customers, take advice, and seek guidance.
Here are some tips to crowdfund as an investor –
Before you invest in a project you’re interested in, be sure to find out
- How much needs to be raised
- How long the campaign has to reach its goal
- The shares offered
- How the contribution will be used
- How many people have already invested?
Invest only 10% of your investment budget for the year or money you can afford to lose. Thankfully, the advantages here allow you invest small amounts.
Check the Financial Services Register to confirm that the platform is authorized. Know the rules of the website and what happens to your funds if things don’t go as planned. You can also look to the UK Crowdfunding Association to make complaints if they come up.
In conclusion, there’s no denying that crowdfunding can be beneficial to all involved. Weighing the advantages and disadvantages can help you decide if it’s best for you or not.
