What is crowdfunding: The 4 types explained

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The crowdfunding industry is dynamic and ever-changing! Crowdfunding has assisted over a million startups and the fundraising market is projected to grow to $300B by 2030! Crowdfunding is on track to change the landscape of business and personal financing by enabling new ways of raising funds. 

We wrote this article to provide you with a basic understanding of the power of crowdfunding, the main types of crowdfunding, the advantages and disadvantages, risks and the best crowdfunding platforms.

What is crowdfunding and how does it work?

Crowdfunding is the collection of small sums of money from a large number of people in order to raise funds to start or assist a business or project, as well as for personal loans and charitable causes. It’s mostly done on social media and through specialised crowdfunding apps or platforms. 

There are 4 types of crowdfunding. Some are regulated by governments, while others are not.

  • Peer-to-Peer (P2P) lending and Equity crowdfunding are regulated.
  • Project-based and Donation-based crowdfunding are not regulated.

How exactly does crowdfunding work? 

Crowdfunding allows anyone to invest a certain amount of money, no matter how large or small. This is a fantastic idea because it eliminates the need for you to apply for a business loan or play nice with a wealthy sponsor as part of your funding campaigns. One of the most significant advantages of crowdfunding is that you can pitch your idea at any time, and if investors like it, they can fund it with as much money as they believe your idea is worth. There are no minimums, maximums, or long-term commitments. When it comes to crowdfunding as a means of raising business or personal capital, most countries impose legal restrictions designed to prevent inexperienced individuals from putting too much of their savings into a business that may fail.

Personal loans are also increasing in popularity these days. If you need money for home improvements, a wedding, or to consolidate high-interest debt, you should think about getting a personal loan. When used wisely, an unsecured personal loan can help you fill the gap in your budget without putting your home or other assets at risk. Unlike a business loan where you can receive way more money, a personal loan is an installment loan that provides you with a fixed amount of money, typically ranging from €1,000 to €50,000, in one lump sum.

The 4 main types of crowdfunding

This guide offers precious pieces of advice to assist you in understanding the 4 most types of crowdfunding. It also outlines their advantages, disadvantages, risks of each one and of course, a selection of the best crowdfunding platforms out there!

Type 1: P2P Lending

P2P lending is a type of debt financing in which people borrow and lend money to one another without the involvement of banks. This type of alternative funding has been around since around 2005 and is becoming even more popular. Typically, P2P lending links borrowers and lenders via online marketplaces (crowdfunded loan platforms), which act as a matchmaker to facilitate the loan/investment. They are regulated to ensure lenders are protected.

The best P2P lending platforms 🏆 

NameLaunched AVG. return Min. investment Loan types
PeerBerry201710.91%€10short, long, leasing, real estate, and business loans
ReInvest24 2018 14.80% €100 real estate equity loans
EstateGuru 2014 11.20% €50  short-term, property-backed loans
Bondster 2017 13.90% €5 consumer and short-term loans, secured business loans
LenderMarket 2019 13.80% €10 consumer and real estate-backed loans

Advantages and disadvantages of P2P lending

Whether you’re thinking about making your first peer-to-peer investment or you are looking to borrow money for your next personal or business endeavor, it’s essential to know the benefits and drawbacks of doing so.

We have created 2 tables for borrowers and investors down below that describe the advantages and disadvantages for each. 

Investors: Advantages and disadvantages of P2P lending:

AdvantagesDisadvantages
An asset class with little correlation to the macroeconomy – Even in a bad economy, peer-to-peer lending can provide consistent returns.Risk of borrower default The risk of borrower default is the most significant disadvantage of peer-to-peer lending. That’s why you should diversify.
Steady returns While stock and bond prices can fluctuate dramatically, P2P lending is typically an all-or-nothing proposition.Lack of opportunity If a new loan comes up ready for funding, and it’s very attractive, you might be unable to invest because others jump in first.
Diversification Most peer-to-peer lending platforms provide a variety of options to diversify your investment.Poor customer service Not always the case, but customer service may come short.
Protected loans – Business loans could have collateral as protection, while unsecured P2P loans have a buy-back guarantee by the loan originator.Platform failure Losing money due to a P2P lending site going bust. Again, we insist on diversification – many loans, many platforms!
Cashing out via secondary markets – The investor can buy and sell loan parts from and to other investors on the secondary market. This type of trade is advantageous because it allows investors to cash out their investments. Losing profit via secondary markets – Keep in mind selling early could reduce your profits by 1-2%.

Borrowers: Advantages and disadvantages of P2P lending:

AdvantagesDisadvantages
A simple and quick application process – P2P lending platforms operate online and the loan application process is both fast and convenient, similar to a traditional lender.Personal inspection To ensure that you’re creditworthy, many platforms may still require a lot of personal information to determine your eligibility for loans.
Suitable interest rates – P2P lending platforms compete with traditional lenders, so they will frequently offer you the rates and terms needed to remain competitive.Application fees P2P platforms could require you to pay a loan “origination fee” but it’s one of the ways they make a profit.
Less impact on credit score – When you apply for a personal loan, many P2P platforms will not run a hard credit check. If they had the same stringent requirements as banks, they would be less useful to borrowers.Lack of regulation – P2P lending is a rapidly expanding industry, and regulators are still defining how to classify its services.
More flexibility – One of the benefits of personal peer-to-peer lending is that loans can be unsecured. Businesses will need collateral.Higher interest rates – Interest rates on peer-to-peer loans may be higher than those provided by traditional banks or building societies. 

P2P lending risks

  • Not enough diversification (concentration risk for the investors).
  • Losing money due to bad debts (credit risk – possibility of a loss resulting from a borrower’s failure to repay the loan).
  • Losing money due to a P2P lending site going bust (platform risk for the investors).
  • Selling into a loss (crystallising losses for the investors).
  • Reduced real earnings due to inflation (inflation risk).

Type 2: Equity-based crowdfunding

Unlike donation- and reward-based crowdfunding, equity-based crowdfunding allows contributors to become part-owners of your company by exchanging funds for equity shares. Your contributors will receive a monetary return on their investments as well as a portion of the profits in the form of a dividend or distribution as equity owners.

Best equity-based crowdfunding platforms 🏆

NameYear launched AVG. return Crowdfunding Type
Seedrs20129.84%Equity-based
Crowdcube 2010 6.00% Equity-based
Fundedbyme 2011 12.36% Equity-based
Companisto 2012 15.00% Equity-based
Invesdor 2012 8.08% Equity-based

Advantages and disadvantages of equity-based crowdfunding

Advantages:

  • You can receive a large sum of money: You can raise up to €75 million per year through equity crowdfunding (and every year, if you decide). This is advantageous if your startup needs a significant amount of funds to launch or develop.
  • A wide range of businesses can use equity-based crowdfunding: Traditional lenders commonly prefer to lend to well-established businesses that have been in operation for a number of years. Equity crowdfunding, on the other hand, may give you a chance to gain investment capital. If you are already a successful restaurateur, you may be able to fund a new restaurant. However, if you are new to the restaurant business, it will be difficult to find investors willing to take a big risk on your brand-new venture.
  • There is no credit or collateral required: If you can’t get a traditional business loan because you lack adequate collateral, equity crowdfunding can help here.

Disadvantages:

  • Your information is widely available: Not only will your balance sheets be made public, but you could also be required to publicise a business approach that you would prefer to keep hidden from rivals.
  • Platforms collect fees and additional costs: Each equity crowdfunding platform wants a percentage of the funds you raise. However, there are additional costs. These expenses include the essential campaign video, company disclosures, marketing costs, and accounting and legal fees.
  • It could be time-consuming: While some campaigns meet their fundraising goal in hours, like the majority of “overnight successes,” many hours were probably invested before then. Plan on a six-month campaign, and you’ll be happily surprised if it goes quicker.

Equity-based crowdfunding risks

  • It can take years for you to see a positive return.
  • Liquidity is not possible.
  • Startup that is fraudulent.
  • Percentage share dilution is a risk.

Type 3: Rewards-based crowdfunding

Individuals contribute to a project or business with the expectation of getting a non-monetary reward, such as services or goods, in exchange for their contribution later on.

Best rewards-based crowdfunding platforms 🏆

NameYear launched Crowdfunding Type
Kickstarter2009rewards-based 
Indiegogo 2008 rewards-based 
Crowdfunder UK 2020 rewards-based 
Pozible 2010 rewards-based 
Patreon 2013 rewards-based 

Advantages and disadvantages of rewards-based crowdfunding

Advantages:

  • It is one of the least expensive ways to raise capital.
  • There is no requirement for collateral, a credit check, or prior business experience.
  • The procedure is straightforward and does not necessitate the assistance of a professional financial or legal advisor.
  • You retain complete ownership and control of your company.
  • The exposure gained on the platform can aid in the development of clientele and brand awareness.

Disadvantages: 

  • Because you rely on individual donations, rewards crowdfunding isn’t the best option for businesses looking for large sums of money.
  • If you do not meet your goal, you may be forced to return any funds raised.
  • Pitching your idea online puts it in front of funders — and competitors. Protect yourself with patent rights to avoid getting your idea stolen.

Rewards-based crowdfunding risks

  • Pitching your innovative solutions online exposes your product to your competitors, who will be watching closely.

Type 4: Donation-based crowdfunding

Donation-based crowdfunding refers to any crowdfunding campaign without financial benefit to the investors or contributors. Donation-based crowdfunding initiatives are commonly used to fund disaster relief, charitable organisations, nonprofit groups, and hospital expenses.

Best donation-based crowdfunding platforms 🏆

NameYear launched Fees Crowdfunding Type
GoFundMe20102.09%Donation-based
Mightycause 2006 $59/month Donation-based
Donorbox 2014 1.5% Donation-based
Fundly 2009 2.09% Donation-based
Classy 2006 $199.00/month Donation-based

Advantages and disadvantages of donation-based crowdfunding

“Goodness is about character – integrity, honesty, kindness, generosity, moral courage, and the like. More than anything else, it is about how we treat other people.” – Dennis Prager

Kindness has the potential to make the world a better place! A random act of empathy can increase feelings of confidence, emotional control, happiness, and optimism. They may also inspire others to recreate the good deeds they have witnessed, thereby contributing to a more positive community. There are no advantages or disadvantages to being kind to others and doing what you are capable of by heart – The good deeds are contagious and there are no risks of being good to other people!

BONUS: Diversification is probably the key to a successful investment! 

Crowdfunding will continue to grow as the economy improves. More and more individuals will become engaged in this exciting new industry! It’s also clear that many people have lost their money because they failed to diversify properly. As with any investment, only invest money that you can afford to lose – and remember to diversify your risk by investing on multiple crowdfunding platforms!

Crowdfunding FAQs

  1. Can I make money from crowdfunding?

One of the most exciting developments in the field of investing in recent years has been the development of investment crowdfunding. With this new type of investing, you may be able to profit from startups, expanding businesses, and even real estate in ways that were not previously possible.

  1. Can I crowdfund a house?

Crowdfunding platforms can now be used to invest in real estate or even raise sufficient money to cover the cost of a home purchase. While crowdfunding a home purchase sounds like a great alternative to getting a mortgage, there are some drawbacks.

  1. Do you have to pay back crowdfunding?

With loan-based crowdfunding, investors receive their cash back, usually with interest. People put money into investment-based crowdfunding in exchange for a stake in your company. So they’ll see the value of their shares varying, but you won’t have to repay their investment.

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