Crowdfunding is a recent and very popular way to raise money. In this article, we will explain what it is and the four main types of investment that can be made using this system. Finally, we will show you the advantages and disadvantages of crowdfunding.
Crowdfunding - Definition
Crowdfunding is also called "crowdfinancing" in English and is the combination of two words: "crowd," which means a large group of people, and "funding," which stands for raising money.
Crowdfunding is an alternative form of financing that is particularly popular with startups, but also with other companies, artists, and individuals.
The focal point of the funding is the so-called crowd, which is the largest possible group of people who financially support a project.
Anyone who needs money for a specific project can consider launching an online crowdfunding campaign. Some crowdfunding platforms apply even strict criteria for selecting projects to be presented to the public in order to protect the investor and present concrete projects. Any person who is convinced by the proposed idea can therefore financially support the project. The financiers are also called crowdfunders.
Crowdfunding differs from traditional forms of financing mainly in the following points:
- Many different donors (actors) and not just one;
- Donors have little or no influence on company processes;
- Coordination and implementation through special exclusively digital crowdfunding platforms;
- High level of public attention through various marketing measures;
Crowdfunding is based on the "all or nothing" principle. At the beginning of the campaign, the entrepreneur or the founder of the campaign sets a minimum amount needed for the realization of the project. If this amount is not reached during the collection period, it ends unsuccessfully, and the sums collected are returned to the investors without fees.
In the context of crowdfunding, there are 4 different types. Let's see the differences together:
Reward-based Crowdfunding
With this type of crowdfunding, the entrepreneur provides a material reward.
Participation in a crowdfunding campaign is therefore not always motivated solely by financial reasons, but often also by idealistic and moral ones.
Example:
A young entrepreneur wants to bring a newly designed product to market. However, they lack the financial means for initial production. Instead of asking for a loan, they create a crowdfunding campaign on the Internet. Those who participate with a minimum amount of 200 euros will receive the product as a thank you, even before it is available on the open market.
Equity-based Crowdfunding
This form of financing takes the form of an equity investment.
Under this system, crowdfunders will share in the company's success, i.e., its profits, by purchasing company shares.
In this type of crowdfunding, the startup can also offer shares with administrative rights, i.e., voting rights at shareholders' meetings. In this case, investors will be invited to participate and vote in meetings regarding strategic business decisions.
Ordinary shares always provide for economic rights, i.e., rights to profits and the sale of one's share at any time or under the same conditions as the sale of majority shares in the event of an Exit.
Example:
Entrepreneur Mario Rossi needs 100,000 euros to start his company. He can provide 55,000 euros of his own capital. Another 45,000 euros are missing. He has the opportunity to draw attention to his project through a crowdinvesting platform. Anyone convinced by the idea can financially support the project. In return, every investor will then share in the company's profits based on the financial resources made available for the project. The investor may have a great financial return following the sale of 51% of the company to another market player (so-called Exit).
Lending-based Crowdfunding
Crowdlending is similar to a bank loan. Every crowdfunder who participates financially in the project in question receives a fixed interest rate in return for a certain period of time. The percentage can vary depending on the campaign, but it is usually between 4 and 10 percent gross per year. Unlike crowd investing, in this case, the return on investment does not depend on the company's success. This form of investment is typical of the real estate sector.
Example:
As before, Mario Rossi's company can be used as an example of crowdlending. Unlike crowd investing, however, with crowdlending, the capital providers do not participate in the profits of the newly formed company, but receive interest on the invested capital.
Donation-based Crowdfunding
In this type of crowdfunding, investors do not receive any financial or material consideration for their participation. The donation is evidently made for idealistic or social reasons.
Example:
Donation-based crowdfunding is used, for example, to request financial support for social projects (humanitarian causes and works).
Considerations
The type of crowdfunding that investors like most is certainly equity crowdfunding. Only this allows for reaching very high levels of economic return. Indeed, more and more startups are going public after a few years, accessing the free stock market (the value of shares explodes) or succeeding in an Exit to some giant in their sector.
Pay attention! High earnings imply high risks. Crowdfunding is a wonderful system for "sharing economy" and distributing wealth, but it must be remembered that most startups fail, and therefore you can lose all the money invested. How to protect yourself? By relying on platforms that carefully evaluate projects before offering them to the public and by studying the business plan and the team's skills.
Advantages of crowdfunding
Crowdfinancing has advantages for both entrepreneurs and investors:
- It is a particularly simple and quick form of investment to implement.
- You can participate even with a relatively small amount of capital.
- It can yield capital gains much greater than the invested capital (there are success stories where the company's value has grown 1,000 times compared to the initial value; this translates into an economic return of 1,000,000 euros on a hypothetical initial investment of 10,000 euros).
- The duration of crowdfunding campaigns can have a fixed and relatively short timeframe (30-90 days).
- Crowdfunding is more transparent than, for example, buying stocks. As an investor, you know exactly which project your invested capital will be used for. On the other hand, when you buy stocks, all you know is which company you are supporting, but not which projects will actually be carried out with the money.
- For company founders, crowdfunding offers the opportunity to raise the necessary capital relatively easily, unlike traditional forms such as bank loans, which often reject loan requests. A crowdfunding campaign requires significantly less collateral than when applying for a bank loan.
- Furthermore, crowdfunding has the advantage for entrepreneurs of being able to test the market before the planned entry. With a crowdfunding campaign, you can discover how many other people are convinced by your business idea and whether there are many potential customers.
- Last but not least, crowdfunding allows not only to financially support the project but also to find potential customers. As a rule, people support projects as investors only if they are convinced by them.
Disadvantages of crowdfunding
In addition to the advantages mentioned, crowdfunding also presents some disadvantages for investors compared to other investment options:
- The contract can only be terminated in the event of service interruption or sale of shares, in the case of equity crowdfunding.
- Crowdlending and crowd investing are forms of subordinated loans. If the borrower declares bankruptcy, this means for the crowd that all other creditors of the borrower will participate in the assets before the crowdfunders receive the share to which they are entitled.
Main crowdfunding platforms in Italy:
We list below the main equity crowdfunding platforms present in Italy; take a look:
- Mamacrowd
- Crowdfundme
- StartsUp
- NextEquity
- Opstart
An interesting project
Within the sites we mentioned earlier, you will find many projects in which you can invest; you will need to carefully evaluate which ones are most suitable for you.
However, I want to leave you the link to a project that I find very interesting.
The startup I want to talk to you about is already present in the market with innovative products; the reference sector, that of food supplementation, is growing every year in double digits (> +10%), they have an interesting digital positioning strategy, and the team is very strong: click here to find out more!
Let us know what you think and….. we are waiting for you!