What rewards are on offer?
Different types of rewards are on offer to encourage investors to put up their money.
There are a few varieties of crowdfunding. “Rewards-based” crowdfunding offers investors things like tickets, preorders of new products or memorabilia. You’ll recognise the market leaders – CrowdPress, Kickstarter and IndieGoGo are known for helping high-profile products like Pebble smart watches and the Veronica Mars movie.
The “equity-based” version exchanges upfront investment for slices of the value of the company – portions of its equity. Craft beer producer Brewdog is a well known example of this.
Finally, “donation-based” crowdfunding rewards people with the knowledge that they are funding a worthy cause. Check out CrowdRise to see some fundraising campaigns.
In crowdlending, the crowd acts as moneylender. In return for the loan, the borrower promises to pay back the capital with interest over a set term. Crowdlending borrowers can be businesses or ordinary consumers, and sometimes the terms peer-to-peer lending or peer-to-business lending are used for essentially the same process. In the US, it’s increasingly called marketplace lending.
Borrowing from the crowd: Which way is best?
Equity crowdfunding and crowdlending have different requirements and make different demands on borrowers. It is not a question of simply better or worse.
Loans require the borrower to prove they are able to make the repayments. Information such as credit scores, bank account statements and, for businesses, cashflow records and management accounts are offered to demonstrate that they have sufficient cash to meet the commitment and they have the ability to manage their money. In order to have this track record companies must have been in operation for at least a few months.
Equity and rewards-based crowdfunding are often used when there the borrower hasn’t got a track record yet or because the amount of money is disproportionately large. For this reason both start-ups and very small companies often use these types of finance.
When looking for crowdfunding investment, the company or entrepreneur puts together a “pitch” detailing their plans.
For rewards-based crowdfunding the investor payoff is relatively simple – a defined, tangible reward – so the pitch is angled toward simply generating publicity.
However the returns from investing in equity are complex and unpredictable. Investments often do not pay back at all. For that reason, an equity pitch has to be very detailed. It may include business plans, competitor and industry research, cashflow forecasts, sales predictions and much more. They may have to answer criticism, conduct additional research and manage a promotional campaign over weeks or months.
When a company is looking for debt, the process is simpler for both borrowers and lenders:
The borrower has to supply documents such as cashflow forecasts and management reports, and they must adequately explain who they are and why they want the money. But they won’t have to create a video or manage a long-term promotional campaign.
Meanwhile, the investor has documentation of the company’s performance and current situation on which to base their decisions, rather than simply plans and projections.
Crowd investing: Risks, repayments and exit strategies
In crowdlending, the borrower agrees to make repayments on a pre-arranged schedule. Investors know the precise amounts of each instalment and the timetable to which they should (all being well) receive their money. This makes it very attractive as the payouts from many other types of investment, for example stocks, are influenced by a large number of variables.
In equity investment there can be a number of exit strategies which might pay the investors back. The potential reward for investing in a company that gets bought out can be huge, but such occurrences are much less predictable. Furthermore, as the majority of start-ups fail – only half survive the first five years – it’s much more likely the entire investment will be lost. For this reason many consider equity crowdfunding to be more suited for experienced, high net worth investors.
However, all types of investing come with risk. Investors should assess which types of investment suit their preferences, and consider how each will fit into the strategy of their wider portfolio.
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