What Is Crowdfunding? How It Works & Different Types
The global crowdfunding market is growing, and crowdfunding is now one of the most popular ways to raise money in Europe. The annual average volume of funds raised per crowdfunding platform increased by 17% from 16M EUR in 2021 to 19M EUR in 2022.
As of March 2023, 594 crowdfunding platforms were operating in Europe, with some of them operational in multiple countries.
Crowdfunding is not just beneficial for those who are raising the funds. It is also profitable for those investing the funds. So, what is crowdfunding and how does it work?
There are several different types of crowdfunding campaigns, including equity-based crowdfunding and reward-based crowdfunding, two of the most popular types after real-estate crowdfunding. Crowdfunding can also overlap with crowdlending or peer-to-peer lending.
If you find all these terms confusing, don’t worry. We define crowdfunding, explain how it works, and examine the different types in the guide below.
What Is Crowdfunding?
Crowdfunding involves raising funds through a group of individuals. It does not entail repaying the money raised with interest on a fixed schedule, like crowdlending does. However, there are different types of crowdfunding, and some do involve offering a reward or incentive for contributing funds.
Crowdfunding in business, like crowdlending, refers to raising capital for a business. It is often the only solution for entrepreneurs and start-ups who would not qualify for traditional loans from banks and similar financial institutions.
Because certain types of crowdfunding offer investors rewards or equity, these alternative arrangements free borrowers from the burden of having to repay a loan with interest. They would not have this option with a traditional bank loan.
Crowdfunding vs Crowdlending
Before we go any further, let’s clarify the difference between crowdfunding and crowdlending.
- Crowdfunding describes raising capital via a pool of individuals but outside of a fixed loan repayment structure. Crowdfunding does not require remuneration or interest to be paid on the sum raised.
- Crowdlending, or peer-to-peer (P2P) lending, is a type of crowdfunding. It describes the collective funding of loans by a pool of individuals. These loans are repaid according to a fixed schedule, with interest. Crowdlending is most typically, although not exclusively, used to finance business loans for startups.
How Crowdfunding Can Revolutionise Your Funding Projects
Business crowdfunding often appeals to investors because they can help their peers start a business while also earning good returns on their investment in that business. But crowdfunding’s main advantage over traditional methods of raising capital can be summed up with one word. Convenience.
It goes far beyond convenience for borrowers. Investors, too, benefit from easy access to investment opportunities.
Comparison to Traditional Fundraising Methods
Crowdfunding is much easier to set up than a conventional business loan. Everything can be arranged via a fundraising campaign on an online crowdfunding platform. And when you contribute to crowdfunding campaigns, you can reap rewards for doing so, without carrying the entire financial burden.
Rather than a large sum from one individual, individuals pool funds to reach the amount required. This makes it more affordable, and therefore more attractive, to potential investors. This makes crowdfunding convenient for both the businesses requiring the funds and the people contributing the funds.
How It Works: Crowdfunding Campaigns From Start to Finish
Part of crowdfunding’s allure is its easy setup and administration. Everything can be done online with the support of the platform site. This means that careful consideration must be given to the selection of such a platform though.
There are countless crowdfunding websites, some based in the U.S. or Asia, many of them in Europe. Your selection should be reputable, compliant with financial laws, and preferably experienced in the type of crowdfunding you wish to engage in.
But the choice of platform aside, there are several steps to follow for successful crowdfunding campaigns.
The ‘Why’
Before you start to invest funds, before you even choose a platform to invest it on, your crowdfunding involvement starts with the initial idea.
It may be an idea to help a completely new business get started in return for business equity or interest on a loan. Or you may wish to facilitate a new product launch for an existing business, in return for royalties or rewards. You could also simply be looking for good investment opportunities for earning passive income.
This is why you decide to contribute the capital they need. Your initial idea may give you clues as to who your best options for investing your funds may be, and how much funding you’ll need to contribute. Consider what exactly your idea will need to bring it to fruition.
Choosing a Crowdfunding Platform
Next, you need to decide where to put your business idea into practice, which means choosing a crowdfunding platform. There are many crowdlending and crowdfunding platforms, each with unique investment opportunities and affiliated with different regions.
Select the crowdfunding platform that best meets your preferences. For example, if you’re looking to help new entrepreneurs with start-up capital, choose a crowdfunding site specifically catering to business crowdfunding.
Setting Your Investment Goal
Next, set your crowdfunding investment goal. Business investment success is always more attainable with a clearly defined goal. You may be motivated to help a certain number of people or contribute a specific sum. Perhaps you are driven by the potential for receiving equity or good interest on loans.
Determine the amount of money that you need to invest, and how long it will take for you to reach your goal. Ensure that the crowdfunding platform you chose is the best one for your specific investment goals before you invest money in it.
Finding The Right Investments
It’s time to determine which of the platform’s crowdfunding investments will help you earn the returns you’re hoping for. Each crowdfunding campaign details what the funds are needed for, how much is needed, and how the funds will be used.
Borrowers do this to get investors interested in their ideas and eager to finance them. You’ll also learn what you will get in return for your contributions.
Types of Crowdfunding
Crowdfunding is a way to raise capital through pooled funds, contributed by individuals rather than banking institutions, yet is not structured like a typical bank loan. Therefore, although financial contributors are often rewarded for their participation, these funds are not always repaid with interest.
Much depends on the type of crowdfunding campaign. This brings us to the different types of crowdfunding.
Donation-Based Crowdfunding Campaign
In donation-based crowdfunding, you donate money to support the business idea or project without expecting anything in return. It is more prevalent in non-profit organizations. However, you may sometimes wish to do this for small start-ups.
Rewards-Based Crowdfunding
Rewards-based crowdfunding involves offering a reward for financial contributions. These rewards will differ depending on the entrepreneur or business asking for financial assistance.
Examples of commonly offered rewards include free products, services, and memberships. These rewards may be proportional to the value of the amount you have contributed.
Equity-Based Crowdfunding
Equity crowdfunding is when contributors are rewarded with a stake in the company or a percentage of the company’s (or product line, if applicable) net profits.
This is a form of venture capital, similar to when venture capitalists provide capital in return for an equity stake in a promising startup. As an investor, you will now own a share in the company.
Royalty-Based Crowdfunding
Royalty-based crowdfunding is when investors are offered a percentage of the revenue accrued from the project or venture. However, if you choose to contribute to this type of crowdfunding campaign, you will only receive the royalties once the venture starts to generate revenue.
Debt-Based Crowdfunding
This is where crowdfunding meets crowdlending or peer-to-peer lending. In debt crowdfunding, the borrower will not have to give up any equity in the company. But investors have their money paid back to them, with interest, in a fixed period.
This bypasses financial institutions and is arranged on an online peer-to-peer lending platform like Maclear.
You may decide that you require the loan to be paid back, with minimal or even no interest. However, crowdlending or P2P lending is structured to offer you the best possible return on your investment, through interest on loans.
Key Takeaways
Crowdfunding is a popular alternative to traditional bank loans for raising funds. It can be used to pay for various things but is gaining popularity as a method of raising capital for a business or creative project.
There are different types of crowdfunding, from donations-based campaigns to those offering a reward, royalty, or equity in exchange for funding. And debt-based crowdfunding, also known as crowdlending or peer-to-peer lending, allows you to receive the money you invest back, with interest.
The returns are often more than you would earn in a savings account, therefore crowdfunding and especially crowdlending can provide you with a good source of passive income. But to ensure that all transactions are legitimate and safe, always use a trusted P2P lending platform like Maclear.