Crowdfunding, which is a method of financing a business venture through a large pool of individual investors, emerged in the late 1990s as the internet began to grow. But its rise to become a mainstream source of funding accelerated in the late 2000s - powered by two key drivers. The first was the boom in social media which created the necessary exposure for an idea, invention or initiative along with the links to potential investors.
The second driver was the global credit squeeze of 2008/09 that saw the major money lenders impose tighter restrictions on funding. Unable to find support from these conventional sources, entrepreneurs turned to crowdfunding as a viable alternative.
Since that time crowdfunding has grown and in 2015-2016 generated $34bn of capital for projects worldwide. Forecasts suggest it will continue to grow with World Bank figures predicting the annual funding value raised will total almost $100bn by 2025.
As the amount of money has increased so the industry has consolidated into crowdfunding platforms. These act as online hubs by drawing together potential investors and entrepreneurs and include major businesses such as IndieGoGo, Kickstarter and Crowdfunder.
A host of specialist agricultural platforms have also emerged like Rang De in India, the Nigerian project Farmcrowdy and US-based Agfunder.
These have flourished because crowdfunding is particularly suited for rural start-up businesses which are often more distant from the conventional urban-based money lenders. In some large countries, farms may be located thousands of kilometres from the major financiers and social media is the only way for their ideas to gain the necessary exposure for investments.
Crowdfunding investment types
Crowdfunding investments fit into one of three broad types - donation, debt or equity.
Under this type of crowdfunding, which is also known as reward funding, backers usually pledge money to a venture because they have a social or personal belief in the cause. There is no expectation of a return on the investment but sometimes the successful business will reward contributors with acknowledgements, free gifts or services.
Contributors in a debt crowdfunding model enter into a financial agreement with the business they are supporting. Anyone who contributes funding to a venture receives interest on their original investment once the business has reached a certain stage of financial security.
Equity crowdfunding agreements provide investors with a slice of the business in the form of shares. The contributors receive financial reward when the business returns a profit in the form of a dividend but the value of the share may also decline if the venture does not perform.
Crowdfunding pros and cons
• Freedom from monthly repayments (donation funding)
• Feedback from wide audience during setup
• Exposure to potential customers during setup
The major benefit of crowdfunding is that a venture can be financed without a formal monthly repayment plan which would otherwise be imposed by a conventional lender. The absence of a repayment plan is helpful for cashflow particularly in the early stages of a business when returns are typically slow to materialize.
The crowdfunding process itself also provides a benefit for the venture. Because the business is exposed to a range of investors early in its development, the entrepreneur gains vital feedback before financing is committed. This allows a degree of fine-tuning of the product and helps to ensure the final incarnation already meets customer requirements at launch. It is also likely there are potential customers, both among the investors, who have committed to the product, and within the broader audience of the crowdfunding pitch.
• Target fund may not be reached
• Funding campaign can add a heavy workload
Crowdfunding does have pitfalls and although statistics on failed ventures vary widely, they suggest that between three to nine out of 10, do not reach their target. These failures may be due to a lack of interest in the product itself, but others suggest that organizing and publicizing an effective funding campaign takes many businesses beyond their skillset.
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