Understanding the market

Features Posted 11/12/16
James Codling, Co-founder and MD of equity investment platform VentureFounders, explains the methods of crowdfunding.

The term crowdfunding is becoming increasingly used in the mainstream. Yet as the market evolves, its meaning is becoming distorted.

While crowdfunding is essentially a group of individual investors committing small amounts of capital to finance a business venture, it is used as a “catch all” term for lots of different investment models, the main types being: donation-based, reward or pre-payment-based, loan-based and investment-based crowdfunding.

Donation-based crowdfunding

This model is fairly self-explanatory. It asks people to commit funds with no expectation of receiving anything in return. While this “free money” might be attractive to businesses, the reality is that it typically attracts very small levels of investment, so a large volume of investors are required to raise a significant amount.

Reward, or pre-payment-based crowdfunding

Like donation-based, this typically attracts smaller investments because the contributor has no continued investment in the business, instead receiving one-off tokens (usually the product or branded merchandise), which typically increase in prestige as the amount committed increases.

Loan-based crowdfunding

This is also known as peer-to-peer lending and is where individuals lend money to a business in return for interest payments and a repayment of capital over time. Loan-based crowdfunding is regulated by the Financial Conduct Authority (FCA) and can attract larger individual commitments from investors, because of the more attractive returns.

Investment-based crowdfunding

This is where investors directly, or indirectly, commit funds to a businesses by buying investments such as shares or debentures. Investment-based crowdfunding is also regulated by the FCA and, again, can attract larger investments based on the potential for long-term returns.

Even within these different types of crowdfunding model, no two platforms operate in the same way. Take the investment space, where my experience lies. “Traditional” crowdfunding tends to conjure up images of lots of people with a bit of spare cash investing relatively small amounts in very consumer-led products. However, while VentureFounders does access a group of investors, we normally co-invest alongside a leading backer, such as an “angel investor” or VC firm, who are putting in a large chunk of the fundraise total. Our investors are, on average, investing about £10,000 (usually in B2B companies and usually with some sort of tech focus).

That’s just one example how the different nuances of crowdfunding platforms, even within the same model, make the investment experience from one to the other very different.

Using the crowd is a great way to find funding for your business and all the models work well for different businesses. The stage your business has reached will in part determine the route you might take. For loan- and investment-based crowdfunding, to attract the investment you not only need to be able to show investors that your company has the potential to provide them with a return but also your objectives. For example, B2C companies can use crowdfunding as an effective marketing tool to raise awareness and publicity for your product or service.

Before embarking on a crowdfunding campaign, it is important to also factor in your plans. You need to be careful about how many investors you take on and how much they’re really committed to your business. Having too many small, unengaged investors means you could miss out on getting them to follow their money (and potentially invest substantially more) when you look for scale-up funding in the future.

Instead, I would recommend building up a loyal investor base who will be keen to support you as you continue to scale and grow.

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