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What is crowdfunding?

Written by Leonardo Hadi · 1 min read >
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Crowdfunding is a process of raising capital in small increments from many investors using an online platform. It is the most popular way for entrepreneurs to get money and launch their businesses. On the other hand, traditional financing like a bank loan requires collateral, credit check, and due diligence.

It provides the most convenient way for entrepreneurs to showcase their business ideas, attract investors, and launch their products. The platform offers an opportunity for non-institutional investors to invest early. Moreover, it gives the entrepreneurs a medium to connect directly to the public and market their products.

There are two types of crowdfunding:

  1. Reward-based
  2. Equity-based

Reward-based crowdfunding: what is it? How does it work?

Reward-based is a type of seed financing from individuals in return for a product or service. For instance, a coffee shop owner rewards an exclusive coffee mug for contributions of more than $100.

It is popular for small businesses in the creative sector. Many of them have compelling products, but they do not qualify for a bank loan. Anyone can contribute and launch a campaign by signing up online. However, the campaign needs a strong social media presence because the individual donation is small. The platform charges a percentage of the total amount raised. The fee is ranging from 3% to 15%.

Pros:
  • Low cost
  • Simple process
  • No collateral, credit check, and legal fee
  • Full control of the fundraising campaign
  • Provide exposure to a large audience and create brand awareness
Cons:
  • Small amount
  • The platform will forfeit the campaign when not meeting the fundraising goal
  • Exposure to competitors
  • The competitor may steal the ideas
Reward-based crowdfunding platform:

Equity-based crowdfunding: the start of a startup

Equity-based crowdfunding works similarly to the stock market. The company issues stock or part of the business’s ownership in return for cash from the investors. However, the company will remain private until it is qualified to go for Initial Public Offering (IPO).

The individual who invests in the company must be an accredited investor because the shares are private. It means that the individual must have an annual income exceeding $200,000 per year or a net worth exceeding $1 million.

However, the Securities and Exchange Commission (SEC) relaxes the rule on accredited investors. It allows an average individual with professional knowledge, experience, and credentials to participate in a private offering and equity-based crowdfunding platform [1].

How does it work?

The entrepreneurs can create a pitch, describe the business, and provide the financial statements. So, the investor can evaluate the prospect of the investment. The company can raise to $1 million in 12 months for early-stage and increase the increment over time.

Equity-based crowdfunding is the best way to take small businesses to the next level by getting direct access to investors. Besides, it can be a useful tool for promotion, sales, and marketing. The crowdfunding site will take a percentage of the amount of capital raised.

Pros:
  • No guarantee
  • Receive funding from multiple investors
  • A successful campaign can create a buzz and open new opportunity
Cons:
  • Equity-based crowdfunding gives up ownership to other investors
  • The entrepreneur may have less control as new investors can influence how the business should run
  • The company must follow the security law and report the business performance regularly
Equity-based crowdfunding platform:

Photo by Toa Heftiba on Unsplash

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Written by Leonardo Hadi
MBA from the University of Illinois at Urbana-Champaign (UIUC). Quantitative Hedge Fund Investor. Profile

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