Crowdfunding – how does it work?

What is crowdfunding?

Crowdfunding refers to using many individual people that generally invest small amounts of money into a business, cause or any type of project. The power of the crowd allows raising quite high amounts of money if the idea is appealing or the business promising. There are in principle four different types of crowdfunding:

  • Equity-based crowdfunding: Equity crowdfunding refers to many individuals investing money in return for ownership of a company or organisation.
  • Loan-based crowdfunding: Loan crowdfunding refers to many individuals lending money to a company, organisation or individual.
  • Reward-based crowdfunding: Reward crowdfunding refers to many individuals giving money in return for a reward which can be a product of the company or any other reward of material value.
  • Donation-based crowdfunding: Donation crowdfunding refers to many individuals giving money for something they don’t expect any material return for. However, the beneficiaries will often update the donators on what has happened with the money.

Usually modern crowdfunding happens entirely online. This means that all the information is available through the homepage of the crowdfunding network that presents the crowdfunding opportunity. However, in case of substantial financial investments such as equity-based crowdfunding and loan-based crowdfunding, physical presentations might complement the offering. As such different start-ups present their ideas and plans during one evening and potential investors have the chance to talk to the key people and get a personal feeling for what they invest in.

What are the advantages of crowdfunding?

Crowdfunding has advantages for both the funders and the receivers. For the receivers it offers the opportunity to get access to funds that they would not otherwise have. In particular, idealistic and not-for profit projects have a much higher chance of getting a little amount from many individuals compared to big amounts from a few. What is more, the receivers of the funds can retain more control over their venture. If you rely on big donors or investors, you become much more dependent on them which you can avoid bringing on board many small contributors. For funders, crowdfunding offers the chance to invest even small amounts into companies or support important causes with limited contributions.

What are the best crowdfunding platforms?

There are many smaller and bigger crowdfunding platforms. An example of a well-functioning equity and lending platform is the Sweden based company FundedByMe. It offers detailed overviews of the companies you can invest in and you can get comprehensive financial details about the different investment opportunities. Other major crowdfunding platforms are Kickstarter, GoFundMe and Indiegogo.

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Dr. E.

Dr. E. has a PhD in Financial Economics and loves giving advice about finances. His mantra is, if you can avoid fees, you win!

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