How Does Crowdfunding Work: A Guide for Investor
Crowdfunding is a rapidly growing industry across the world, which has a big potential for both businesses and individuals looking for funding as well as investors. But, one might ask, what is crowdfunding? This is the process of raising capital from the public for an individual, business, campaign, or project.
How crowdfunding works
Today, we have over 100 crowdfunding websites spread across the world. Now, when you visit any of these websites, you should see various projects pitched. Typically, one is required to register with the site for them to see the extra details, see the pitches, or invest in any project.
When you see a project that you are interested in, go ahead to get more details about the project. Here are a few details that the individual, social enterprise, or business should tell you about their project:
- The amount they’d like to raise
- How much they’ve raised
- The share you will get in their business (if relevant)
- Reasons why the need the funding
- For how long the pitch will be open
- The number of donors or people who have already contributed
- What you shall get in return after investing
With crowdfunding, your investment can only progress when the business raises the required amount. Typically, most crowdfunding projects have a 14 day buffer period in case a donor or investor changes their mind.
Major types of crowdfunding
The following are the 7 types of crowdfunding:
- Peer-to-peer lending – in this form of crowdfunding, a crowd offers money to a business, with an understanding that the business will repay the money with interest. You can compare this to the traditional loans from a bank, only that you will be borrowing from many investors.
- Equity crowdfunding – this involves the sale of a certain stake of a business to different investors and then get a certain investment percentage. We can compare this crowdfunding idea to venture capital or to the stocks sold or bought at a stock exchange.
- Reward-based crowdfunding – here, people donate to a business or a project, with expectations of getting a non-financial reward in return. This can happen at a later state in exchange for their contribution.
- Donation-based crowdfunding – in this form of crowdfunding, people will donate small amounts, to meet a greater funding goal for a certain charitable project. However, there’s no form of material or financial gains for donors with donation-based crowdfunding.
- Revenue-sharing or profit-sharing – here, a company can share its future revenues or profits with the crowd in return for their funding now.
- Debt-securities crowdfunding – this requires individuals to invest in a debt security that’s issued by a business, like a bond.
- Hybrid models – this allows you to combine different elements of more than one type of crowdfunding.
How do investors benefit from crowdfunding?
Experts from Stokr, an online investment platform say that the major point of attraction for crowdfunding is the chance for high returns on your money, unlike the returns you get in other forms of investments like publicly quoted shares or bonds. Only a few other financial tools provide the potential to grow your wealth as much as investing in a start-up business does. When you invest in the right business, you have the opportunity to double your investments—however, this will depend on the success of the business.
Because of their risk profile, investing in start-up business can be categorized as a separate class of assets, which can assist investors to diversify their investment portfolios. The traditional forms of investments required people to invest large sums of money in one or two businesses, which is very risky. However, crowdfunding allows you to spread your investments across numerous businesses. With such kind of investment, you will not be putting your eggs in a single basket.
Most businesses normally give investors gifts and rewards. Typically, this includes discounts, free products, vouchers, as well as other benefits specific to that company.
The intangible benefits
These are the non-physical benefits, like the joy of knowing that you assisted a business to grow their ideal, creating new contacts, or getting an opportunity to learn more about investments.
The risks of crowdfunding
Just like all other types of investments, crowdfunding has its risks. However, the stakes are a bit higher with crowdfunding, especially when you choose to invest in a young business. The following are the risks of crowdfunding that investors face:
- The risk of losing your money – since most businesses looking for crowdfunding opportunities are startups, there’s a chance that you will lose your money if the business doesn’t succeed.
- The returns are not guaranteed – with crowdfunding, there’s always a chance that the shares might not increase in value, meaning the investor won’t get any dividends.
- Selling your shares can be a challenge – because the shares that you get are unlisted, you might have a challenge in selling them as you would sell the shares of a company listed on the stock market.
- The crowdfunding platform might fail – with this, you can lose your money if you had paid the crowdfunding platform, and it fails before investing the money in a business.
With that, investors need to be very careful with crowdfunding. Always take your time to research the business that you’d like to invest in, and check other people who’ve invested in that business. This will help you to make the right choice and reduce the chances of losing your money.