What is crowdfunding?

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With start-ups and small businesses finding it harder and harder to obtain bank finance, crowdfunding and crowd-lending have fast become mainstream and viable sources of funding.

But what is crowdfunding?

Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people… typically via the internet.

Despite the practice coming of age in recent years, thanks to the internet, crowdfunding as a concept has actually been around for a long time.

In 1885, when the US Government failed to provide funding to build a monument base for the Statue of Liberty, a newspaper-led campaign attracted small donations from 160,000 donors. The rest, as they say, is history!

There are three basic types of crowdfunding:

  1. Rewards-Based Crowdfunding;
  2. Equity Crowdfunding;
  3. Peer to Peer Lending (P2P).

Rewards Based Crowdfunding

Rewards Based Crowdfunding is where people give funds to a business or idea, in exchange for goods or services. Investors do not own shares in the business and will not share in any potential financial reward.

Equity Crowdfunding

Equity Crowdfunding is where the crowd actually purchase shares in the business. As shareholders in the business, the investors will share in any upside should the business succeed.

Conversely, if the business fails, then the investors stand to lose all of their investment.

Peer to Peer Lending

Peer to Peer Lending is where individual investors lend cash to businesses, which normally put up some form of security. The returns are generally higher than those of a traditional financial institution, but much lower than the potential returns from equity crowdfunding.

To make the crowdfunding model work, there are three parties involved.

Firstly, the project initiator or entrepreneur, who proposes an idea or project to be funded;

Secondly, the investors (or the crowd) who support the idea financially;

And finally, to bring it all together, a moderating organisation or platform that allows funding arrangements to be put in place.

Most importantly, this organisation must be regulated, so as to protect both the investors and entrepreneurs; and ensure that everything is done legally and above board.

In the UK, the regulatory body that oversees Crowdfunding is the Financial Conduct Authority or FCA.

Before investing in a start-up via a crowdfunding platform, you should make sure that the platform you are investing through is authorised and regulated by the FCA.

Crowdfunding has come a long way in a very short space of time. It’s is a great way of bringing much needed funds to innovative ideas, while at the same time, allowing everyday investors to take stakes in companies that were previously only accessible to venture capitalists and large institutions.

Watch the video above for more detail.

To learn more about elements of crowdfunding, visit the rest of our articles on The Hub.

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