Crowdfunding is a relatively new source of alternative financing which was integrated into the U.S. market in 2012 with the release of the Jumpstart Our Business Startups Act or JOBS act.
$17.2 billion is generated yearly through crowdfunding in North America only, according to Fundera
See full text
In 2018, the crowdfunding market accounted for 6,455,080 of worldwide crowdfunding campaigns last year and is projected to reach 12,063,870 by 2023.
What is crowdfunding and why is it growing so rapidly? Will it replace the traditional banks or loan services?
To find out the answers to these questions, we should start with the basics.
What is traditional finance?
Financing a business is the process of gathering funds through debt and equity using traditional finance sources:
- Bank loans;
- Credit unions;
- Angel investors;
- Venture capitalists.
Despite the fact that the first bank was established roughly in 1791 in the USA and in 1397 in Italy, loans have been out there forever.
Taking a bank loan is a tough procedure entrepreneurs because banks don’t really care about the idea, vision, or Instagram profile filled with fancy images.
Banks, credit unions, and VCs are mostly interested in strict numbers, business plans, marketing strategies, existing sources of income, credit score and a number of other written and unwritten factors. In addition to that, banks and credit unions are even more interested in your collateral for a loan.
Nevertheless, if all the financial and business audit is in place, and the collateral is a juicy one, an entrepreneur can expect to get a large loan from a single entity in just 7-14 days.
How crowdfunding alters traditional finance
Crowdfunding is an online type of alternative financing which provides an opportunity to raise capital from the crowd.
However, the crowd doesn’t mean passersby. Usually, these are accredited individual or corporate investors or unaccredited investors that meet the minimum criteria which is different for every country.
All of the investments are done through a crowdfunding platform which works as an intermediary and connects businesses with investors.
Crowdfunding alters traditional financing in several impactful ways:
- Allows investors to start with around $50 to $50,000;
- Doesn’t require businesses to provide a collateral;
- Funds are gathered from multiple investors in much smaller portions compared to a bank loan;
- Provides more opportunities for startups to take off the ground;
- Contributes to the local and global economy on a micro level.
To provide an example of a crowdfunding platform one may propose Kickstarter or Indiegogo, but that would be wrong for this particular article.
Both Kickstarter and Indiegogo focus on reward-based crowdfunding which works similarly to e-commerce and doesn’t require the platform to be registered with the SEC, FCA, or other country-specific regulatory institutions.
When it comes to startup investing, crowdfunding platforms either debt or equity are operating under different requirements for fundraising portals and broker-dealers.
However, despite its type, a crowdfunding platform will do prior due diligence anyway. Companies that are looking to get funds from such platform will have to provide the following information:
Comprehensive description of the product, idea, and vision including prototypes or MVPs (more details provide more chances to hit the funding goals);
A solid business plan and marketing strategy;
Pass KYC verification.
This information is required to minimize the risks for all investors, fundraisers, and the platform itself.
What risks of crowdfunding exist
No startup investing is risk-free neither is crowdfunding. Being an intermediary, a crowdfunding platform is responsible for conducting thorough KYC checks and AML verification procedures to ensure both compliance and safety for investors and fundraisers.
A platform puts its reputation at stake while investors put their money in and fundraisers disclose vital business information.
- IP Theft - business information is disclosed and stolen;
- Fraud - platform abuse, insincere campaign funding;
- Money laundering - credit card fraud, illegal sources of funds;
- Underfunding - campaign fails to reach its goals;
- Overfunding - campaign overperforms and a company needs to release more equity.
Usually, the whole risk reduction and mitigation set of procedures is done by the platform itself. So a platform owner should be proficient and savvy to make sure everything works smoothly and securely.
The major benefits of crowdfunding
As a way of alternative financing, crowdfunding is opening new opportunities for all investors, fundraisers, and crowdfunding platform developers.
Benefits for investors include:
- A new investment instrument;
- Investor portfolio diversification;
- Debt and equity investments for non-accredited investor;
- Participation in large deals that were inaccessible before, etc.
Benefits for fundraisers include:
- Less intense check-up process compared to banks;
- No need for collaterals;
- Access to a pool of investors;
- Additional marketing and exposure;
- Early-stage idea validation through crowdfunding, etc.
Benefits for crowdfunding platform developers include:
- New business opportunities;
- Multiple niches such as debt and equity crowdfunding in real estate, agriculture, healthcare, automotive, technology, etc;
- Relatively easy to launch;
- Growing demand (funds raised through crowdfunding grew 33.7% last year, according to Fundera)
Crowdfunding is not a threat but rather an advancement of traditional finance. The concept and technology behind crowdfunding appeals to large groups of people and contributes to the economic growth worldwide.
Unlike speculative cryptocurrency or the blockchain hype, crowdfunding provides real value for the SMEs and investors worldwide.
Whether you’re an investor, fundraiser, or an entrepreneur, crowdfunding is something to look into in 2020 and the upcoming years.