Four Types of Crowdfunding | LegalVision UK (2024)

Beginning a new business or project within your existing business can be exciting. However, you typically require funding to begin work. Crowdfunding can be a great way to generate the funds to bring your ideas to life. Each type of crowdfunding has its advantages and disadvantages. You need to choose the right type for your business and its needs. This article will explain the four types of crowdfunding and their advantages and disadvantages.

Crowdfunding to Start Your Business

Crowdfunding offers an alternative to traditional methods of business funding. Entrepreneurs, startups, and businesses often use it to fund new businesses, projects, and products. It can allow you to secure capital by gathering a pool of funds on an online crowdfunding platform where many people put (often small amounts of) money into one pot. In this space, you can showcase your idea and find an audience.

There are four common types of crowdfunding, these are:

• rewards-based;
• equity-based;
• debt-based; and
• donation-based.

It is important to understand the different types of crowdfunding to find the most suitable type for your business.

1. Rewards-Based Crowdfunding

Rewards campaigns are a popular method of crowdfunding. You will seek funding by offering rewards as incentives to those who provide support. You can offer different rewards based on the amount backers contribute. For example, if you are looking to start an innovative gardening business, you may offer the following rewards:

• an allotment gardening ebook to those who donate £10;
• a branded t-shirt and the previous reward to those who donate £25;
• a gardening toolkit and all previous rewards to those who donate £50; and
• a garden consultation and all previous rewards to those who donate £200.

Advantages

Using rewards-based crowdfunding provides you with access to people who are interested in the project. If people are interested in the rewards related to your project, they will also be interested in the project itself. Accordingly, you have a market audience to consult as your business develops. Furthermore, you can build a community among the backers.

Disadvantages

The disadvantages of rewards-based crowdfunding include not attracting big investments, as many investors seek financial returns. Additionally, you may experience additional pressure to fulfil rewards as a result of an unexpectedly successful campaign.

2. Equity-Based Crowdfunding

Equity crowdfunding, also known as investment-based crowdfunding, gives contributors a financial stake in the company they invest in. Accordingly, you provide backers with a portion of equity in your business. Compared to the other types of crowdfunding, it is directly in the interest of equity-based backers that your business succeeds.

Advantages

This form of crowdfunding is advantageous as it provides access to long-term support from investors. As they have a financial stake in your business, investors will be more interested in providing as they are interested in its growth and profitability.

Additionally, the potential for significant investments can make equity-based crowdfunding attractive to entrepreneurs. As there is a financial benefit to investing in your campaign, equity-based crowdfunds are likely to attract people willing to provide more money in exchange for financial returns.

Disadvantages

Dilution of ownership is one of the most significant disadvantages of equity-based crowdfunding, as you provide others with equity in your business. How much you give away is within your control, but you will reduce your ownership and control level if you do.

Likewise, regulatory complexity is another disadvantage. Compliance with regulations around issuing shares and managing shareholders may discourage people from this form of crowdfunding.

3. Debt-Based Crowdfunding

Debt-based crowdfunding, or loan-based crowdfunding, is a form of crowdfunding whereby individuals lend money in exchange for the promise of repayment with interest. You will specify the timeframe within which you will pay back the money. Investors act as lenders, and the online crowdfunding platform facilitates the lending process.

Advantages

This method can serve as an alternative for those who are ineligible for bank loans. Furthermore, you can negotiate the terms of the loan agreement with backers.

Disadvantages

A significant disadvantage of this type of crowdfunding is the loan repayment obligation. Other forms of crowdfunding do not require repayment. As with all forms of lending, there is risk involved with accumulating debt. Moreover, interest costs can increase the overall cost of financing your new project.

4. Donation-Based Crowdfunding

Donation-based crowdfunding involves donations from a community of supporters. Donors do not expect financial returns, rewards, or repayment. Instead, they contribute from goodwill, empathy, or a desire to support a cause.

Advantages

You can generate capital through donations without any obligation to repay or reward backers. A community of donors are evidence of market validation of your prospective business venture or new project.

Disadvantages

Your project may have limited appeal as contributors do not earn any financial or material rewards. Furthermore, there is greater competition on donation-based platforms.

Key Takeaways

Crowdfunding offers diverse funding opportunities. Choose the method that aligns with your short and long-term goals. The four common types are:

• rewards-based crowdfunding;
• equity-based crowdfunding;
• debt-based crowdfunding; and
• donation-based crowdfunding.

If you need legal advice about starting or funding your new business venture, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.