Crowdfunding is growing to be one of the most popular ways of raising equity today. In 2022 too, the segment is expected to grow at 3.6%, and reach a value of US $33.20 billion in Australia. It opens avenues for both investors and those looking to invest. The method has its pros and cons and should be taken on after due diligence has been conducted and businesses have weighed their alternatives.
This article covers the main types of crowdfunding, its benefits, and pitfalls so you can be prepared when you exercise this option to raise funds.
What is Crowdfunding?
Crowdfunding is a way through which businesses, organisations and individuals can raise alternative funds. They can choose to fund a business without the conventional methods of funding by receiving small donations from many people. The cash flow can be used to fund projects, or help start-ups take off and launch themselves in the industry.
Most crowdfunding campaigns are through crowdfunding platforms on the internet, have a time frame for raising money, and have specified amounts and monetary goals.
Generally, if the project meets the funding goal, the platform transfers the pledged amount to the company raising funds. If the project does not meet the funding goal, it is cancelled, and no money is transferred.
Types of Crowdfunding
There are 4 broad types of crowdfunding:
- Equity
Equity crowdfunding refers to when a company raises money by issuing shares to retail or non-professional investors through online crowdfunding platforms. Hundreds of investors can potentially invest in the company. Typically, private companies cannot have more than 50 shareholders, however, crowdfunding laws have eliminated this hurdle for companies.
Only companies that meet the crowdfunding criteria can raise funds from more than 50 investors. Having met the criteria, a company can raise $5 million within a year with each investor being able to invest up to 10,000. Following are the criteria that make companies eligible to engage in equity crowdfunding:
- The company should have 2 directors.
- The company’s principal place of business should be in Australia.
- The company’s consolidated gross assets and annual revenue have not exceeded $25 million.
- The company should raise funds through an approved intermediary e.g., Equitise, VentureCrowd, OnMarket, etc.
Additionally, the company will have to comply with disclosure and other reporting obligations, which can be onerous for early-stage start-ups.
- Donation
One of the most common types of fund-raising is used to ask for funds in exchange for non-monetary rewards. This is usually used to fundraise for causes you care about – these can be personal or social. The returns can be tangible or intangible, e.g., happiness or contentment or having the finished project as the reward (local community park).
- Debt
Debt crowdfunding is also often referred to as peer-to-peer lending. This involves asking a crowd of investors to donate in exchange for potential financial returns at a later stage. These returns can be in the form of dividend-like payments. However, the returns will depend on the terms of the initial investment.
Debt crowdfunding is used by companies when they wish to pay off other financial obligations e.g., a loan or to pay back other liabilities. It can also be used by companies that need capital but would rather pay back in funds as compared to equity. Fundraisers need or mention what the money is needed for, and when can investors expect repayments.
- Rewards
Rewards-based crowdfunding is often used to raise funds for start-ups that offer products or services. In return, the investors can get rewards such as free merchandise, handmade items, prizes or gift cards or vouchers for the products or services offered by the fundraiser or their partner companies.
- Real Estate
Real estate crowdfunding is a relatively recent type but is gaining popularity rapidly with investors looking to invest in real estate. Through crowdfunding approaches, these investors can avoid the hassle of applying for loans or shouldering the obligations of owning property solely.
In this approach, individuals invest collectively to buy property e.g., a large apartment building. Each investor can choose to invest small amounts depending on how much ownership they wish to have. In return, they can receive payouts each quarter or semi-annually depending on the revenue the property generates.
Benefits of Crowdfunding
Crowdfunding helps individuals and businesses raise money relatively easily by reaching out to a massive public audience. It is faster and more convenient than the traditional channels of seeking debt or equity or loans to invest in businesses.
The crowdfunding approach also works favourably for smaller companies, non-profit organisations or creative organisations that face greater hurdles in the traditional fundraising channels.
The help that investors and the public can offer as part of crowdfunding can be beyond the monetary aspect. They can assist by giving feedback on projects, helpful advice or even lending their efforts to marketing activities.
Companies can test the market and their offerings quicker and more conveniently without having to do a pilot separately. Additionally, crowdfunding offers individuals a chance to invest at multiple price points. Hence, investors too can get convenient and lucrative investment opportunities that fit their budget and are hassle-free.
Risks of Crowdfunding
Crowdfunding exposes you to a wider audience than other traditional methods. However, not all these individuals will be potential investors. Your idea or start-up will also be exposed to competitors, inhibitors and regulatory authorities which can raise complications with your legal and tax obligations.
Companies also then have to comply with disclosure and public reporting obligations which may not suit start-ups. Equity funding also requires an intermediary which increases the cost of fundraising. For effective crowdfunding, you will need a well-developed campaign.
The development, management and carrying out of the campaign can be a costly process, both in terms of money and effort. As an early-stage company, these efforts can take a heavy toll on your business.
Crowdfunding Avenues
While several crowdfunding websites exist, relying on them may be dangerous for investors and costly for the business. Such websites do not take any responsibility for the funds raised or the companies raising them. Hence, as an investor, you will need to carry out due diligence.
As a business, you will have to pay them a cut of the funding as a fee for processing the collection and transfer of funds. You will need to weigh in the funds you are raising and the amount you will be spending on the campaign and the website to raise those funds.
Key Takeaways
Crowdfunding is a method of raising alternative funds from the public.
- There are 4 main types of crowdfunding that are used for different purposes. You can choose which one best suit your cause and your organisational goal.
- Crowdfunding gives easier and hassle-free access to funds, and investors can invest small amounts as per their budget in profitable projects.
- However, crowdfunding also brings on additional scrutiny with increased regulatory obligations and investors must carry out their due diligence before investing.
- While crowdfunding is becoming increasingly popular, regulations are limited and are in development. This can make crowdfunding a risky endeavour for both businesses and investors.
Crowdfunding is starting to be regulated as a fundraising alternative by the government. However, since it’s a relatively new concept, there are changes to policy and obligations which can be hard to keep track of.
As a start-up, if you are looking for funding options, crowdfunding is one of the many that you can explore. But you should do so with an experienced legal counsel.
Our start-up legal experts at Lazarus Legal have helped countless start-ups reach aspiring heights and navigate the industry’s dynamic landscape through sound and tailored legal advice that furthers your business goals. You can connect with us today for a consultation and find out how we can help you with your legal concerns.
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Mark Lazarus
Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.