Crowdfunding, crowdsourcing, tribe building… just some of the terms that are becoming everyday language in the business world today, but 15 years ago, these terms did not exist! So what has brought about this new vocabulary? Answer ….An alternative finance revolution!
Crowdfunding has changed the way start-ups, big companies and individuals raise funds, it’s a way of unleashing people power to source the money required for a project. In reality it has decentralised the banking monopoly by bringing together investors and people in need of finance. Here’s how it works: On one side, there are the campaign creators, those who have a new, innovative and entrepreneurial project, to be submitted onto a platform for funding. And on the other side, the crowdfunding community who gets to decide which project to give monetary support to in exchange for a reward or return.
HISTORY OF CROWDFUNDING
While the industry has grown significantly in recent times, it is not a new concept. As far back as 1606 the Dutch East India Company used the power of the crowd in order to fund the lucrative venture of conducting trade between Europe and Asia. In the 1880's, hundreds of small donations from everyday Americans helped to pay for the plinth upon which the Statue of Liberty stands. Public subscription similarly funded the construction of Nelson’s Column in London’s Trafalgar Square.
While there is a global reach through digital connectivity, in reality crowdfunding usually works much closer to home when people set up a page on a platform and distribute the URL to friends, family members, email contacts and people in their personal social media networks. Conversations with local newspapers, social media channels and bloggers can sometimes get the message carried further afield.
4 CROWDFUNDING MODELS
Today there are 4 main crowdfunding models which is one reason it has such a wide appeal around the world, evidenced by the fact that the sector doubled year on year until it was worth a whopping $34billion in 2015.
- REWARD – In this model people can ‘pledge’ funds for a project in return for a predetermined reward. Companies like KICKSTARTER and INDIEGOGO, who started around 10 years ago, are now household names. This is not an investment and those that support this project do not get equity or share profits but rather often receive a new product at a discount or something with intrinsic or emotional value. This successful crowdfunding model was quickly applied to craft and hobby sectors as many people with original and unconventional products were drawn to this innovative way to promote their items to wider and larger audiences than using local craft markets. Reward platforms usually operate an all or nothing policy, so the set target must be reached if the funds are to be received.
- DONATION – In this model people can give or donate to a social or charity cause. Participants do not receive any reward or a tangible return. A good example of this type of platform is JUSTGIVING. The role of the platforms is to provide a marketplace where people can ask for donations to their project, and donors can be confident in the platform handling the transactions in a timely and professional manner for their money to reach the fundraisers.
- DEBT/ LOAN – In this model the investor receives a fixed interest payment for a given period of time from the Venture and at the end of the loan period, the loan is to be repaid in full. Borrowers must usually be an existing business that has progressed beyond a “proof of concept” stage and provide either a two year trading history or put up security against the value of the loan. This is a type of investment crowdfunding which is a regulated activity. ZOOPA and FUNDING CIRCLE are examples of companies in this space.
- EQUITY – In this model the investors can have “skin in the game” by receiving shares in the Venture in which they are investing. This is a type of investment crowdfunding which is a regulated activity. While the risk is greater than debt/loan there is also potential for greater returns or profit shares. After the 2008 economic recession, there was an opportunity to connect high net worth individuals who had money they wanted to put to work, with Startup businesses that needed funding. There are also tax advantages using the EIS scheme for qualifying projects.
REAL ESTATE CROWDFUNDING
One of the biggest growth sectors in the crowdfunding industry is in the Real Estate or Property sector. Fundraisers can open up investment opportunities to networks of small scale investors or High Net Worth’s in order to raise capital. People are able to invest collectively in property deals that would be beyond their means on an individual basis allowing them to share the developers’ risks and rewards.
Real estate/property crowdfunding can operate on a debt or an equity basis, with properties either held longer-term to generate a rental income or sold upon completion or refurbishment – ideally for an immediate profit. It is important to note that money is at risk. Property crowdfunding can be a more flexible way to invest than equity crowdfunding as estimates of any given property’s value are readily available.
CROWDFUNDING AND REGULATION
Both DEBT/LOAN and EQUITY crowdfunding are regulated activities in the UK. Promotion of investment opportunities is a regulated activity under the Financial Services and Markets Act 2000.
Investors should carry out their own due diligence to establish what is the level of risk and weigh that up against the value for money being offered by the investment.
Crowdfunding Platforms may only make direct offer financial promotions to retail clients if such clients either:
- have taken regulated advice or passed an appropriateness test
- are high net worth or sophisticated investors
- have confirmed that they will invest less than 10% of their net assets in the relevant investment.
Regulated platform operators must also be able to assess whether retail clients understand the risks involved with investing if they do not take regulated advice – this should be done as part of the online registration process for the platform.
While crowdfunding is an exciting way to raise funds, it must be noted that not every campaign succeeds, in fact across the 4 models probably more fail than are successful. It is therefore imperative to do your homework and understand the elements of a successful campaign. In fact, there has been a new generation of consultants that have emerged offering their services and expertise.
When a crowdfunding campaign catches the support of the crowd it can be phenomenal with £millions raised from thousands of backers all of which suggests we will be seeing, hearing and reading a lot more about this industry in the years ahead.