What is crowdfunding?
Crowdfunding is the financing of projects or ventures by raising relatively small amounts of money from a relatively large number of people online.
You might have heard about crowdfunding thanks to the successes of companies such as (the now-defunct) smartwatch Pebble or the unicorn Brewdog. Both companies raised to fame and revolutionised industries (wearables and craft beer respectively) thanks to this funding modality. But the fact is that they used very different types of crowdfunding.
Indeed, the definition of crowdfunding is a broad one and encompasses several modalities of funding, not all of them suitable for a startup. Let’s dig into the details and see which ones might fit your company.
Types of crowdfunding
In order to raise the money you need for your project, you’ll need to offer some sort of compensation to the community that will back you. There are 5 types of crowdfunding based on what is offered to backers in return:
1. Rewards-based crowdfunding
With this modality, you’ll be offering offering your backers the opportunity to be the first to try your new product or service.
Essentially, you’ll be pre-selling, even before you’ve had to invest in actually producing the product or service. This has the advantage of validating that there is a product-market fit. In the worst-case scenario, it’s a way to fail fast and (relatively) cheaply.
As you’ll receive the money before delivering the product or service, this will do wonders for your cash flow.
Unfortunately though, long gone are the days when you could upload the project to one of the main platforms and wait for the pledges to arrive. The process involves engaging with an existing community or creating one from scratch, which can be both costly and time-consuming.
Having said that, the advantages can outweigh significantly the disadvantages. Especially if you have in mind to look for investment in the future. The fact you’ve run a successful rewards-based crowdfunding campaign can give you both the community to run an equity campaign and the credibility to convince investors to come on board.
Some examples of rewards based crowdfunding campaigns:
- Video games is one of the biggest categories on the rewards-based platforms. After a massively successful campaign in Kickstarter campaign (over $2m – £1.65m), Star Citizen continued raising money in their own website. So far they’ve raised over $185m (£153m) and counting.
- Fashion brand Cocoro was launched via a rewards-based crowdfunding campaign. Using the power of their community, they have now launched an equity crowdfunding campaign on Crowdcube.
- Food and Drink is also a popular category. For example, meal substitute Soylent was launched via rewards-based crowdfunding
Here are the top 5 most popular rewards based crowdfunding platforms:
- Kickstarter: the indisputable leader, has raised over $4bn (£3.3 bn) for over 168k successful campaigns.
- Indiegogo: the runner up, it has quite an innovative approach and a ‘keep what you raise’ option.
- Crowdfunder.co.uk: quite popular in the UK, it offers interesting match funding options for projects with a community angle.
- Patreon: slightly different approach to the previous platforms. Its subscription model allows creators (YouTubers, Podcasters, bloggers…) to be paid for their creations in a recurrent fashion.
2. Equity crowdfunding
In this case, you’ll be offering equity in exchange for your backer’s money. They will become shareholders in your company.
The UK is a pioneer in this type of crowdfunding, thanks to the progressive laws and regulations in this area (especially compared to other countries like the US, Canada and mainland Europe). The two biggest platforms worldwide are both UK based: Seedrs and Crowdcube.
In terms of how to run a campaign, the most important phase of an equity crowdfunding round is the pre-campaign. For a company raising for the first time, the pre-campaign will last at least 4 to 6 months. The process involves creating a video, a business pitch and, most importantly, warming up a crowd (friends, fools and family, customers, social media followers…) and reaching out to early investors.
It’s important to note that the broader community of the platform will invest along with your crowd – they will not typically lead as they will want reassurance that there is a sizeable number of people backing that investment opportunity.
UK investors will have a clear preference to invest in SEIS/EIS eligible companies, as they will have significant tax benefits. During the pre-campaign, you should apply for advance assurance to demonstrate to investors that your investment will qualify.
After you’re done your homework in pre-campaign, it’s time to launch and promote the campaign via both on-line and off-line channels.
Equity crowdfunding has many advantages (like the amazing end customer engagement that will generate, as they will now become investors) but it’s not suitable for all companies.
The crowd will seek reassurance that there is a good product-market fit and that the company will scale rapidly. Therefore, if you’re at pre-seed or seed stage, perhaps equity crowdfunding will not be for you. Because of their much smaller end-customer base, B2B companies are also quite difficult to crowdfund.
Some examples of equity crowdfunding campaigns:
- FinTech is the darling of this modality of crowdfunding. Challenger bank Chip showed us that you could beat platform records (campaign with most investors) while not losing your sense of humour.
- Another hugely successful category is Food & Drink. The chain of delis Sourced Market raised nearly two million in two different rounds in Crowdcube.
- CleanTech also tends to do quite well. Etergo, a Dutch electric scooter manufacturer, raised over £3m on Seedrs.
The most popular equity crowdfunding platforms in the UK, sorted by amount raised according to the independent data platform Beauhurst, are:
- Crowdcube: in H1 2019, Crowdcube raised £55.6m in 83 raises.
- Seedrs: the second biggest platform by amount raised, actually closed a few more deals than the leader in H1 2019. £36.9m in 98 raises.
- SyndicateRoom: taking a more investor-led approach that their peers, companies need to bring a professional investor to be able to raise investment from the crowd.
3. ‘Bring your own crowd’ platforms
As we’ve mentioned, having a big supporting base is crucial to raise money in the more ‘traditional’ equity crowdfunding platforms. This could be in the form of a high number of very engaged customers and/or big following on social media. That’s why they’re not indicated for the very early stages of a startup or for B2B companies.
To avoid some of the pitfalls of the ‘traditional’ equity crowdfunding platforms, you could consider platforms like SeedLegals to close funding with investors you know like friends, family and early investors in a ‘bring your own crowd’ round, using products such as SeedFAST and Instant Investment.
4. Lending or credit
Also known as Peer to Peer lending (P2P), the pledger will receive their money back with interest. This means that the company needs to be in a position to repay the credit, which is not often the case in early stage startups.In this modality, there is less need to bring a community as the platforms typically attract small lenders happy to support growing companies. What makes it an interesting deal is that the interest received typically beats a regular ISA while offering the same fiscal advantages.
The most popular platforms in the UK are Funding Circle, Zopa, RateSetter and Lending Works
Most typical of charities, NGOs, community projects and individuals, the backer will not receive compensation aside from a very warm, fuzzy feeling inside.
Many of the tactics used in rewards-based and even equity-based crowdfunding campaigns will be also useful to prepare and promote a donation raise.
Some of the popular donation platforms in the UK are Crowdfunder.co.uk, Virgin Money Giving and GoFundMe.
6. Rewards through donation
Perhaps the most obscure of the 5 modalities, they’re a sort of online raffles where the backer will not receive compensation directly but is buying tickets for a relatively big prize, like an experience with a famous person. As the donation projects, they’re suitable for projects with charitable aims.
The most popular platform offering this modality of crowdfunding is Prizeo.
Which type of crowdfunding platform should I use?
Well, there is not a straight answer, but the general rule of thumb is:
- If your company is about to launch an innovative customer-facing product or service, you should definitely consider a rewards based campaign to validate your market fit.
- If you have a clear product-market fit, a potentially broad customer base and ambitions to scale, you’re ready to look at equity crowdfunding to help with your ambitious business plan.
- Once the company has recurrent profit you might opt for a lending campaign to continue growing.
As we’ve already hinted, once you have established a community, doing further rounds of crowdfunding becomes a great way to find further funding and keeping your customers engaged. You could even switch modalities!
- Some companies like Revolut, have been successful in several equity-based campaigns, tapping into the communities
- Other companies like Nomatic have made the rewards-based campaigns their way of launching new products to the market
- Companies like eFoldi, have done hugely successful equity raises after equally successful rewards campaigns. They have even gone back to rewards to launch the next iteration of their product!
So, what does it all mean for my startup?
Crowdfunding is a great way to finance a new venture. Not only you’ll be able to get the funding you need to execute your business plan but you will also engage with your customer base, turning them into brand ambassadors. SeedLegals can help with the process, for example by helping you prepare your SEIS/EIS, or even let you close existing potential investors to get cash into the business faster before you open up your round to the crowd.
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