Types of Crowdfunding For Business: Debt, Equity, Or Rewards
Crowdfunding has become a bona fide economic and cultural phenomenon over the last decade. A report from 2015 found that $34 billion had been raised to date through crowdfunding — a figure that has undoubtedly grown significantly in the time since. Crowdfunding’s public profile seems to grow by the day, with high-profile crowdfunding campaigns for medical emergencies, board games, controversial political figures, and projects like the RompHim (by law, no article on crowdfunding can go without a RompHim mention) becoming viral stories unto themselves. The effects of crowdfunding have been felt far and wide, and while they have facilitated the raising of capital for companies and causes that might otherwise struggle for funds, crowdfunding websites have also been blamed for everything from accelerating political polarization to the decline of IPOs.
In all this discussion about crowdfunding, what gets lost in the shuffle is the fact that the term “crowdfunding” encompasses fundamentally disparate methods of fundraising, grouping them together under the same banner despite the important practical and legal distinctions. I see a need to clarify things by drawing some distinctions between the different types of crowdfunding. I’ll be highlighting the implications of these differences for entrepreneurs and businesses looking to tap the coffers of The Crowd. Different methods befit different ventures, and we here at Merchant Maverick wouldn’t want you to go barking up the wrong crowdfunding tree, wasting precious time and energy.
Let’s zoom in on the three categories into which most of these platforms fall: rewards, debt, and equity crowdfunding.
When the average person thinks about crowdfunding, they’re probably actually thinking about rewards-based crowdfunding websites. That’s because crowdfunding has almost become synonymous with Kickstarter (see our review)– perhaps the prototypical rewards crowdfunding platform — in the public mind. Rewards crowdfunding can be just the ticket for entrepreneurs and small businesses looking to raise money and stay out of debt, particularly if their venture involves the production of tangible goods that can be offered to backers as rewards.
Kickstarter is an example of a pure rewards crowdfunding site. Kickstarter requires that your venture offer tangible rewards to your backers — it’s not optional. The very first rule on their Rules Page states “Projects must create something to share with others.” In Kickstarter’s vision of rewards crowdfunding, the reward is an integral part of the project, not just a side benefit of supporting a campaign. This is why Kickstarter is an ideal crowdfunding platform for creative projects involving gadgets. From 3D printers to Apple Watch chargers to hoverboards, all manners of tech projects have found fundraising success with Kickstarter. Another genre of business project well-suited to rewards crowdfunding is tabletop gaming. In fact, board game campaigns have gotten so popular that the current renaissance in elaborate, art-heavy board games is almost entirely attributable to Kickstarter.
The other big players in the rewards-based crowdfunding field are Indiegogo (see our review) and GoFundMe (see our review). Unlike Kickstarter, however, campaigners are not required to provide rewards to backers — it’s simply an option. Campaigns on these sites that don’t offer rewards are engaged in donation-based crowdfunding, which I’ve chosen not to focus on, as such campaigns are better-suited to personal and charitable causes than business causes. As it happens, Indiegogo is a great place from which to originate a rewards crowdfunding campaign, particularly in the realm of technology and design. If you’re thinking about launching a rewards crowdfunding project and you’ve got something cool to offer potential backers, Kickstarter and Indiegogo are the first places I’d recommend looking. Given Kickstarter’s unmatched ability to draw site views and its second-to-none media outreach, this platform may be the most desirable for a rewards campaign. However, it is also the most exclusive, and many projects have found crowdfunding success with Indiegogo after having been rejected from Kickstarter. Indiegogo is a great platform for art and film projects as well.
As for GoFundMe, you can certainly launch a rewards crowdfunding campaign with them, but considering their brand is much more centered on fundraising for charitable causes and personal emergencies, a business project might struggle to gain traction there. Other platforms offering rewards crowdfunding include Fundable (see our review) and Patreon (see our review).
Rewards crowdfunding platforms typically keep about 5% of what you raise as fees, and the payment processor will take an additional cut — normally around 2.9% + 30 cents per donation.
Now let’s take a look at some additional crowdfunding methods.
The general public may not be as familiar with equity crowdfunding as with rewards- and donation-based crowdfunding, but that’s likely to change as the field expands. Equity crowdfunding bears a superficial resemblance to “traditional” crowdfunding, except that instead of contributing to a project in exchange for a prototype device or some other reward, the backer becomes an investor who receives an ownership stake in the company in question. Essentially, equity crowdfunding involves investments, while rewards crowdfunding does not. Therefore, equity crowdfunding is much more heavily regulated.
For a long time, due to the inherently risky nature of such investments, there was no legal way to conduct an equity crowdfunding campaign. Enabling such campaigns to exist was the main impetus for the passage of the JOBS Act. Conceived of in the wake of the 2008 financial crisis (which dramatically decreased access to capital), the JOBS Act was signed into law in 2012. Among other things, the Act legalized the advertising and solicitation of securities, thus permitting companies to offer equity to investors in public campaigns. Here’s where things get a little complicated.
The various provisions of the JOBS Act did not come into force at the same time. Title II of the JOBS Act, which authorized equity crowdfunding using accredited investors, took effect in 2013. (‘Accredited investor’ is a term referring to those who either have a net worth of $1 million USD excluding the value of one’s primary residence or whose income has been $200K or more over the last two years and who expects to make at least that much in the current year. Basically, ‘accredited investor’ = rich person.) Titles III and IV of the Act, which authorized equity crowdfunding using non-accredited investors, took effect in 2015 and 2016. This means that accredited-investor-only equity crowdfunding has had a bit more time to mature than equity crowdfunding for non-accredited investors.
Crowdfunder (see our review) is a representative example of an equity crowdfunding platform open to accredited investors only. Crowdfunder markets itself as an equity crowdfunding solution for “high-impact ventures” — i.e. business with the potential for exponential growth. In other words, it’s not ideal for, say, a restaurant looking to invest in new equipment. Since backers of an equity crowdfunding campaign are in it for profit and not the promise of owning some new tech gizmo or tabletop roleplaying game, equity crowdfunding may be best suited to companies involved in less “sexy” fields than those that tend to thrive with rewards crowdfunding campaigns.
Other players involved in equity crowdfunding for accredited investors include Fundable — which hosts both rewards and equity crowdfunding campaigns — and Microventures. Fundable makes the point that a rewards crowdfunding campaign can serve as a precursor to launching an equity crowdfunding campaign, as a successful rewards campaign can serve as proof of demand to woo investors to a subsequent equity campaign.
Equity crowdfunding for non-accredited investors is a much newer field, and it may take some time before all the nuances are fleshed out and definitive statements can be made about the nature of the industry. However, companies like Wefunder are now active in this realm, blazing a trail for other equity-crowdfunding-for-the-masses platforms to follow.
Debt crowdfunding bears some similarity to equity crowdfunding. Both involve investing in a security of the company in question. The difference is, instead of receiving shares of the company in the hopes of getting a slice of future profits, the investor gets paid back on a fixed schedule with interest. Basically, instead of borrowing from a bank, you’re borrowing from a crowd of investors.
“Crowdlending” is a good option for a business with a defined need for money, a strategy for what to do with it, and a plan to pay it back. It doesn’t have quite the same novelty as rewards and equity crowdfunding, and it’s probably not the best option for you if you’re the creator of some buzz-worthy gadget or the CEO of some early-stage venture with the potential for exponential growth. Obviously, not every business is going to be eager to take on new debt, so it’s less attractive than other forms of crowdfunding in that respect. However, strictly in terms of your likelihood of achieving funding success, debt crowdfunding is likely the safest bet of the three, as crowdlending sites don’t make your funding dependent on your cause’s virality.
LendingClub, Prosper, and Kiva U.S. are examples of debt crowdfunding sites.
Too much of the capital in our world is held under lock and key by big rent-seeking institutions — precisely where it does the least good. Crowdfunding is a means of bypassing those stingy institutions by directly connecting the businesses that need funds to those with money who stand to gain something — either physical or financial — through said businesses’ success. I’ve given you a rundown of the three primary ways to conduct crowdfunding. None of these methods can be said to be best for everyone. The best way I can break it down is like this:
- Rewards-based crowdfunding is best for startups and businesses with something exciting to offer the public. Gadgets, games, movies, and dining experiences all qualify.
- Equity crowdfunding is best for companies with exponential growth potential but which may lack a singular product or experience that could generate viral enthusiasm.
- Debt crowdfunding is best for startups and stable businesses that need cash for a defined purpose and which have a plan to pay back the loan.
Crowdfunding gives you the ability to raise funds without getting down on your knees and pleading to some impersonal bank, and for that we can all be grateful. It’s still a relatively young industry, with new developments occurring at a rapid pace. Thank goodness you have us Merchant Maverick writers to keep you updated about the latest developments, eh?