A Brief Guide to Crowdfunding

Crowdfunding is starting to take off in a big way and many small businesses are keen to get in on the action. There are various ways of crowd-funding a business, and which one a small business owner chooses depends mainly on what suits the business needs the best. Here are the three most popular crowdfunding options…

Equity-based funding

This allows a business to issue shares in the company in exchange for investment cash. Typically businesses can use an equity-based crowdfunding platform such as CrowdCube to pitch their business to hundreds or thousands of potential investors. People who invest in the business effectively become shareholders, often with the crowdfunding platform acting as the shareholders’ proxy. Businesses taking this route can raise anything from a couple of thousand pounds to hundreds of thousands, and have been known to acquire several hundred new shareholders in the process. However for new startups, often the equity giveaway can be quite sizeable.

Reward-based funding

Businesses not wishing to give away equity in their business can offer some other form of reward in exchange for cash. This is often in the form of a limited edition or ‘first edition’ product. Businesses can pitch their new product, or whatever they are offering in reward for cash, on a reward-based crowdfunding website such as Kickstarter, and ‘investors’ hand over their cash in exchange for the promise of the reward at some point in the future. This method is often popular with brand new startups that are offering a breakthrough product but do not have the capital to start up or any valuation to justify equity-based funding.

Peer-to-peer (P2P) lending

This option allows businesses to raise loan capital without having to apply for an old-fashioned bank loan. Often banks require a credible track record and/or asset based security before lending, which can make loan capital very hard to raise for new startups. Peer-to-peer lending allows a business to pitch their business idea to a crowd of potential lenders, typically through a platform such as Funding Tree, and lenders bid for a small part of the loan at a particular interest rate (sometimes in an auction style). Loan rates are often higher than you would expect with a traditional bank loan, some in excess of 10%, however peer-to-peer business lending is more accessible and tends to focus on the merits of the business plan, and less so on the individual’s credit record.