Types of Crowdfunding
There are several types of crowdfunding campaigns. Sponsors decide on the type of campaign model they want to use based on their needs.
In peer-to-peer lending, several people act as lenders to give money to the borrower, with the expectation that an interest payment along with the principal amount will be paid back to them. Borrowers will accept funds from those who offer low interest rates after a bidding process by these crowd lenders. The loans themselves are small amounts.
Peer to peer lending is suitable for capital restructuring, refinancing, acquisitions, new product launches and expanding to new territories. Companies who are profitable and growing, with stable business can look at peer to peer lending as an option. Pre-profit companies are not good candidates for this form of crowdfunding.
As the name suggests, in equity crowdfunding, investors get a stake in the equity of the firm for advancing funds. Companies seeking funds have to set the terms of the funding, including the price at which to sell and at what level of funding equity will be available. It is mandatory to share disclosure and legal documents, AGM minutes and decisions. The online crowdfunding platform may conduct due diligence.
They also need to communicate if equity holders will have voting rights, degree of control, and the possibility of legal damages if there is a breach of contract. Investors will expect forecasted sales and profit before they invest. This type of funding is suitable for all companies, except those that are in the pre-profit and pre-trading phase.
In reward-based crowdfunding, contributors get a reward such as the product for which the funds were collected once the product is developed.
In this type of crowdfunding, only the promised reward has to be given to investors, no monetary benefit. For companies seeking funds in this manner, it is a sort of pre-sales booking. Innovative product offerings are the best fit for this type of funding. Rewards must be given to investors on time or the reasons for delay must be relayed.
A charitable cause such as helping a child raise funds for an expensive drug is an example of donation based crowdfunding. There is no material or monetary reward for this type of crowdfunding. The reward is the altruistic act of giving and enabling someone to get back on track or tide over a crisis.
This type of funding promises profit or revenue sharing for funds advanced. This means investors receive a multiple of their investment that is set at a percentage of future revenues by the borrower.
The rate of return is flexible and borrowers gain by getting lower effective interest rates. Both these factors mean that the risk of bankruptcy is lowered. Investors often prefer this mode of crowdfunding as amounts advanced are low and since the chance of bankruptcy is lower, repayment rates are improved.
Debt Securities Crowdfunding
The SEC offers exemption to a certain limit (1.07 million in the US as of today) to offer and sell their securities without registering with the SEC. Investors who find participation in early capital raising of startups attractive, choose this mode of crowdfunding. Participation in the campaign is open to all but subject to net worth and annual income, to reduce risk for a period of any 12 months.
Hybrid model Crowdfunding
This form of crowdfunding employs the best of both worlds to raise funds. Usually a lead investor who assesses the company's worth, its potential and forecasts forwards a significant amount in the company. Then pure lenders who trust the lead investor's expertise invest small amounts as they would in a pure crowdfunding. The presence of the lead investor usually results in more public investors extending funds than they would have otherwise.
Who can invest?
While most crowdfunding campaigns are open to all investors, there are some which are eligible only to Accredited Investors. For example, in the US, Accredited investors are individuals having an income exceeding $200,000 or a net worth over $1million. They can also be individuals who hold a general securities, series 7 license or a series 65 financial advisor licence or a series 85 license which allows them to transact business on behalf of a sponsor for their clients. They can trade in unregistered financial securities since they are considered to be financially more aware.
Next, we will learn about the crowdfunding process.
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