Investment 101: The Basics Of Crowdfunding

Getting into the investment world can be difficult. With so many options and varying advice available, it can leave some of us feeling confused and even daunted by the process. However, Crowdfunding can potentially provide an alternative route for people looking to build their portfolio and aid them in considering their future investments.  It allows individuals to invest small amounts of their money across multiple ventures, rather than investing all of their capital into one. 

What is Crowdfunding?

In the past, if an individual wanted to fund a project by investment from others, they would need a large amount of capital in order to do so. ‘Capital’ is used to describe any form of personal wealth, including disposable income, inheritance or other assets a person may own. Without capital, those looking for investment into their business, project or products would have to find another way to raise the money in order to get their project off the ground.

There are a few ways to gain more capital such as securing a loan. Borrowing a specific amount of money can allow a project to go ahead; however, this comes with a level of risk that must be considered beforehand. Taking out a loan can be seen as risky to some due to the requirement to maintain consistent payments and the possibility of a high rate of interest. This means the accrual of debt to pay back the loan itself, but also, as loans typically come with an interest rate, it means owing even more money than has been lent. Failing to stick to a consistent payment plan can also affect credit scores and make future investment almost impossible. 

Another option is to ask family, friends or even a private investor for the additional capital. This is not available to everyone and can sometimes even lead to strained or awkward conversations with loved ones. 

Crowdfunding is another alternative route which is seen as a little less traditional but has risen in popularity since the 2000s. Crowdfunding is the concept of obtaining funding from a large group of people providing crowd validation, investor confidence, potentially faster funding, and a chance to build relationships and a community.

To crowdfund for a business, project or product means being able to request the required funding from a number of people who share a common vision or ideal. Typically, this means that a group of people will band together and make individual contributions of all different sizes to provide the capital necessary.  

As an individual’s investment can range from small to large, this also makes investments available to people who previously had no opportunity to explore the potential wealth an investment into a project or business might bring.

The Four Different Types of Crowdfunding

With the knowledge of what crowdfunding is, it’s vital to understand what the four different types are. 

Firstly, there is the Debt or Loan crowdfunding, which can also incorporate Peer-To-Peer (P2P) Lending. A pool of investors will lend capital towards a project or company and then in return, will receive a debt instrument that they will pay a fixed amount of returns and interest on, until the loan is fully repaid.  It should be noted that there is risk involved in deploying capital into debt or loan instruments and investors should always ensure they have read the risk warnings and taken independent advice.

The second type is Donation based crowdfunding, with websites such as GoFundMe and JustGiving sit. This type of crowdfunding allows individuals to donate a small amount of money to one, larger funding aim. Typically, this is used for a charitable purpose and the donors will not receive anything in return, just the feel-good factor of helping a worthy cause or the knowledge that they helped projects they are passionate about get off the ground. 

Thirdly, is Reward based crowdfunding.  This is where people will donate their capital to an ongoing project and in return, get the use of a service or prototype version of goods.  Typical examples of this type of crowdfunding are Kickstarter and Indiegogo.

Finally, is Equity crowdfunding, where individuals get the opportunity to invest in a business or project in return for equity. This means they have invested in a potentially viable asset and are actively involved in the investment process as passive shareholders. To be a passive shareholder means that the individual’s equity investment is used to fund a project (usually property), but they have no active part in the project, as the fundraiser takes care of the day-to-day business related to the project.  The crowd investors should receive regular updates on the project and in return for their deployment of capital, they may receive a potential Return on Investment (ROI) and in some cases a potential percentage share of any additional profits.  However, it should always be noted with this type of investment, that capital is at risk and returns are not guaranteed and you may lose some or all of your investment.