The 4 Types of Crowdfunding

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A lot of myths and assumptions about crowdfunding are floating around the internet. In this post we will give you an overview of crowdfunding anno 2018 by focusing on the four most important types of crowdfunding: Equity-based crowdfunding, loan-based crowdfunding (crowdlending/p2p lending), donation-based crowdfunding and reward-based crowdfunding.

What is the Definition of Crowdfunding?

Broadly speaking, crowdfunding is a method for raising money aimed at a specific project or venture. Contributions can be both large and small but come from many different agents. Today, crowdfunding takes place online via different platforms thereby bypassing traditional providers of financing like banks or mutual funds. However, there are also examples of crowdfunding projects before crowdfunding moved online. The most famous being…

Many different attempts have been made in making a precise definition of crowdfunding. A few relevant examples:

Merriam-Webster: “[Crowdfunding is, red.] The practice of obtaining needed funding (as for a new business) by soliciting contributions from a large number of people especially from the online community” [1]

The European Commission:Crowdfunding is an emerging alternative form of financing that connects those who can give, lend or invest money directly with those who need financing for a specific project. It usually refers to public online calls to contribute finance to specific projects.” [2]

The U.S. Securities and Exchange Commission:Crowdfunding is an evolving method of raising money via the Internet to fund a variety of projects.” [3]

The U.K. Financial Conduct Authority:Crowdfunding is a way in which people and businesses (including start-ups) can try to raise money from the public to support a business, project, campaign or individual.” [4]

Thus, across definitions of crowdfunding three main elements can be identified, which we will use as a starting point for our understanding of crowdfunding.

  1. A great number of funders is involved in the financing (the crowd).
  2. An online platform facilitates and promotes the contact between the providers and the seekers of capital.
  3. There is an open call to participate in the financing.

Parties Involved in Crowdfunding

Considering the abovementioned elements, we need at least three parties for a crowdfunding transaction to take place:

Providers of funding: Crowdfunding involves different agents that usually do not have any connection except for the common project. Most often, these are private individuals but can also be companies or banks.

Seekers of funding: The seekers of funding are the project owners. These are often either private individuals, small and medium-sized companies (SMEs) or non-governmental organizations (NGOs).

An online platform mediating the transaction: The platform publishes and promotes the projects under its own conditions with the goal of attracting providers of funding. In return, the platform will typically demand a fee.

The designation of the involved parties varies with the different types of crowdfunding. More on that below.

Types of Crowdfunding

In differentiating between different types of crowdfunding an important distinction is between crowdfunding with a non-economic return and crowdfunding with an economic return.

Both categories of crowdfunding can be split into two additional subcategories. In the category of crowdfunding with a non-economic return these are donation-based crowdfunding and reward-based crowdfunding, and in the category of crowdfunding with an economic return these are equity-based crowdfunding and loan-based crowdfunding (P2P lending/crowdlending).

The different types of crowdfunding are illustrated in the figure below. Read along for an in-depth explanation of every part of the figure.

Donation-Based Crowdfunding

Donation-based crowdfunding was the model with which crowdfunding started. In this type of crowdfunding, funders do not obtain any product, rights or ownership. Exceptions to this, can be something of symbolic value. On the other hand, funders have the possibility to donate to a cause they are passionate about. The idea behind donation-based crowdfunding was therefore aimed at raising funds for social projects and charitable causes such as development assistance and NGOs – for example in the form of aid to fugitives or extraordinary help during catastrophes. However, as more and more platforms emerge, donation-based crowdfunding has expanded to include everything from charitable personal projects like help paying for medical treatment, participation in events and support for athletes or art to all kinds of both imaginable and unimaginable projects – some belonging to the more weird and shady category. Therefore, to avoid scammers, make sure to do your homework before supporting a project.

Donation-based crowdfunding is known from sites like GoFundMeRocketHub and CrowdRise.

Reward-Based Crowdfunding

Reward-based crowdfunding is the most common type of crowdfunding, and in contrast to donation-based crowdfunding, funders will, in reward-based crowdfunding, receive a…. reward. This reward is typically a concrete item like a service or product developed and produced with the help of funds from the crowdfunding campaign. For entrepreneurs and companies, this type of crowdfunding is not only an alternative source of financing, but also an effective way to test the market potential of their products.

When considering for example returns, in most countries, reward-based crowdfunding is regulated according to the same rules that applies to internet shops. Also, services and products given to funders by through reward-based crowdfunding are considered as buying and selling services and products. The funders are selling an item through reward-based crowdfunding. 

The reward-based crowdfunding is known from platforms like Kickstarter and Indiegogo.

Equity-Based Crowdfunding

Equity crowdfunding, crowd equity, crowd investing, investment crowdfunding…. They all refer to the same phenomenon, but we prefer the term ‘crowdequity’. The model makes it possible for a large group of people and companies – the crowd – to finance startups and small unlisted businesses. In return for providing capital, the investor will receive a proportionate part of shares in the company. In other words, the investor will provide funding for the company and will in return get a small ownership of the business. The investor will keep this ownership until he or she choose to sell it, or it is liquidated. This stands in contrast to a loan that has a predetermined runtime. More on that under Peer-to-Peer lending/crowdlending below.

Instead of raising money from angel investors, venture capitalists, banks, friends or family, equity-based crowdfunding makes it possible to raise money from “the crowd”. This happens through crowdequity platforms like the once mentioned below. If you want to get started with crowdequity, you can find an overview of crowdequity platforms with sign up rewards here.

From the perspective of the small investor, equity-based crowdfunding has opened the door for investing in startup companies – a door that was previously only open to the beforementioned angel investors and venture capitalists. And thereby, in a larger perspective, equity-based crowdfunding has helped democratize the investment process. With a market for equity-based crowdfunding in rapid growth, one can therefore ask the question – will equity-based crowdfunding help push the agenda towards a more democratic and freer world?

Examples of crowdequity models are platforms like BulkestateCrowd EstateSeedrs & Property Partner.

Loan-Based Crowdfunding

The loan-based crowdfunding is more often referred to as Peer-to-Peer (P2P) lending or crowdlending. To avoid confusion with the general market for P2P investments, we are using the term ‘crowdlending’, since the market for P2P investments are covering both crowdequity and crowdlending. Therefore, on P2PMarketData.com you will find platforms specialized in both types of crowdinvesting.

In crowdlending, both private and professional investors (the lenders) can lend capital directly to companies and individuals (the borrowers) thus bypassing the traditional banks. The lending operation is facilitated by a crowdlending platforms like the once mentioned below. The crowdlending platforms provide standardized terms on interest and repayment and monitors the loans once they are financed. Thus, the loan-based crowdfunding makes it possible for many lenders to finance a single company, which provides the lenders with the possibility to spread their risk across multiple loans. If you want to get started with crowdlending, you can find an overview of crowdlending platforms with sign up rewards here.

Examples of crowdlending models are platforms like BondoraEstateGuruFlenderOctoberMintos and NEO Finance.

Sources

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