Feb 18, 2022
Crowdfunding: New Age Mode of Financing
Crowdfunding is the technique of gathering money from a large number of individuals to sponsor a project or endeavor, most commonly over the Internet in modern times. Although comparable concepts can be implemented through mail-order subscriptions, benefit events, and other techniques, the word "crowdfunding" relates to online registrations. The project initiator, who proposes the idea or project to be funded, individuals or groups who support the concept, and a regulating organization (the "platform") that brings the parties together to launch the proposal are the three categories of actors in the current crowdfunding paradigm. Crowdfunding is used to fund various for-profit businesses, including artistic and creative projects, medical bills, vacation, and community-oriented social entrepreneurship projects. Though it has been proposed that crowdfunding is strongly tied to sustainability, empirical validation has revealed that sustainability only plays a minor impact in crowdfunding.
Pros and Cons of Crowdfunding
The potential to provide access to a bigger and more diversified set of investors/supporters is the most evident benefit of crowdfunding for a startup investing firm or individual. Due to the extensive usage of social media, crowdfunding platforms are a great way to reach a larger audience to receive the funds they need. Furthermore, many crowdfunding initiatives offer incentives to investors; for example, investors may be able to participate in the introduction of a new product or receive a gift in exchange for their contribution. For example, the manufacturer of a new bacon fat soap may send a free bar to each of its investors. Equity-based crowdfunding is gaining traction because it allows startups to raise funds without handing over control to venture capitalists. It may also give investors the potential to gain an ownership stake in the enterprise. Equity-based crowdfunding is regulated by the Securities and Exchange Commission (SEC) in the United States. There is a reputational risk of resorting to crowdfunding. The fees associated with the crowdfunding site are quite high, and if you don't meet your financing target, all-cash promised will be returned to your investors, and you will receive nothing.
Crowdfunding for startups
The use of modest sums of funds from a large number of people to finance a new business initiative is known as startup crowdfunding. Crowdfunding uses social media and crowdfunding platforms to connect investors and entrepreneurs, with the potential to encourage entrepreneurship by broadening the pool of investors beyond the typical circle of owners, families, and venture capitalists. These limitations are intended to safeguard novice or non-wealthy investors from putting too much of their savings at risk, similar to the restrictions on hedge fund investing. Because so many new enterprises fail, investors are at risk of losing their first seed investment. Startup funding can now raise thousands or millions of dollars from anyone with money to invest through crowdfunding. Anyone with an idea can propose it to a group of willing investors through crowdfunding.
Types of Crowdfunding
Reward and Equity Crowdfunding are the two primary types. These categories sum up all other crowdfunds such as Debt-based, Donation-based, and Litigation.
Reward-based crowdfunding has been utilized for a variety of initiatives, including album recording and film promotion, free software creation, innovation development, scientific research, and civic endeavors. Research studies have found a number of characteristics of rewards-based crowdfunding, also known as non-equity crowdfunding. Funding is not dependent on geography in rewards-based crowdfunding. When Sellaband launched royalty sharing, the gap between creators and investors was around 3,000 miles. The financing for these projects is divided inequitably, with a few projects receiving the lion's share of the total. Furthermore, when a project approaches its goal, financing grows, encouraging "herding behavior." Friends and relatives contribute to a considerable, if not the majority, of early fundraising, according to research. This funding may entice additional investors to join the enterprise. While finance is not dependent on location, observations reveal that traditional financing options are generally connected to the locations of funding options. When it comes to reward-based crowdfunding, investors are frequently overly optimistic about project returns and must adjust their expectations when those expectations aren't satisfied.
Equity crowdfunding is a collaborative effort by individuals to provide financial support in the form of equity to projects started by other persons or organizations. Following the enactment of the 2012 JOBS Act in the United States, laws outlined in the act will allow for a larger pool of small investors with fewer limitations. Equity crowdfunding, unlike non-equity crowdfunding, has more "information asymmetries." The creative must not only create the product for which they are soliciting funds but also establish equity by forming a business. Unlike donation and rewards-based crowdfunding, equity crowdfunding involves the offering of assets with the possibility of a profit. Syndicates, which comprise a large number of investors following the strategy of a single lead investor, can help to reduce information asymmetry and avoid the market failure that can occur with equity crowdfunding.
Importance of Equity Crowdfunding
Equity crowdfunding is also known as regulation crowdfunding, as it is regulated by the Federal Government. Your company is still offering equity to investors in exchange for capital, even if you aren't selling shares on a stock exchange. As a result, the procedure has more constraints than a straightforward internet fundraising effort such as GoFundMe or Kickstarter. Guidelines are crucial if you want to use equity crowdfunding to raise funds for your company. Otherwise, you may face unfavorable results. Failure to obey the regulations, for example, may result in you having to return any investments you have received. The Securities and Exchange Commission (SEC) of the United States may even suspend the company's ability to sell shares to investors for a while.
The following are some of the procedures you'll need to take to sell business shares using an internet crowdfunding platform.
- To process any investment transactions, work with an SEC-registered broker-dealer (also known as a funding gateway).
- Allow no more than $5 million in crowdfunding investments each year.
- Follow federal regulations regarding the amount of money you can receive from unaffiliated investors in 12 months (amounts vary based on income)
- Depending on the amount of investment your company receives, make any mandatory financial reports public.
You'll need to create a captivating campaign in addition to legal problems if you want to energize the public and persuade others to invest in your company. A successful equity crowdfunding campaign should provide crucial information to potential investors, such as:
- You'll need to raise a certain quantity of money
- What you intend to do with the funds
- Customers you're looking for
- What is your profit margin?
- What sets your company apart from the competition?
- Why should investors back you up?
Kickstarter is a non-profit organization established in Brooklyn, New York that runs a global crowdsourcing platform for creative projects. The company's declared aim is to "assist in the realization of creative ideas." Kickstarter had generated $6.6 billion in pledges from 21 million backers as of July 2021, enough to fund 222,000 projects ranging from films to music to stage plays to comics to journalism to video games to technology to publishing to food-related ventures. Danae Ringelmann, Slava Rubin, and Eric Schell launched Indiegogo, an American crowdsourcing website, in 2008. San Francisco, California, is home to the company's headquarters. One of the first sites to provide crowdfunding is this one. Indiegogo is a crowdfunding platform that allows people to raise money for a good cause, a charity, or a new business.
AngelList features a syndicated network of investors who cover all setup costs and carry interest, allowing entrepreneurs to raise money for free. By creating an AngelList profile, any startup incorporated in the United States or the United Kingdom can apply for investment; however, syndicates often look for companies with a respectable founding team, demonstrable postlaunch traction, or a prominent offline investor already involved. FrontFundr is an exempt market dealer and Canada's top online private markets investing platform. They help Canadian entrepreneurs bring their ground-breaking ideas into reality by providing startups and growth enterprises with access to finance that helps them expand. The firm also offers investors the chance to invest in these businesses. All Canadians, whether seasoned financial experts or first-time investors, can use the online platform to support the ideas and activities they want to see flourish. They've amassed a community of over 34,000 people, launched over 100 successful funding campaigns, and assisted businesses in raising over $120 million.