Understanding crowdfunding

Crowdfunding is a method of raising finance that lets you secure investment for your business from many people or organisations.

Funding amounts can range from small sums up to millions of pounds. Investors could be other Londoners or London-based organisations, or they could come from across the world.

There are lots of specialist crowdfunding platforms, such as Kickstarter and Seedrs, that can match businesses like yours with potential investors.

This guide takes a look at the main types of crowdfunding for your business and outlines some key considerations you'll need to think about before you use crowdfunding to raise finance.

Types of crowdfunding

There are three main types of crowdfunding that your business could use to raise finance.

Donation-based crowdfunding

Donation-based crowdfunding is a way to raise finance for your business or project by securing small amounts of money from a large number of individuals.

Social and environmental groups and not-for-profit organisations often use this type of crowdfunding. Donors invest because they support the cause, but don't expect anything in return. However, you could decide to give them non-monetary rewards, such as gifts, regular news updates and invitations to exclusive events.

Just Giving is an example of a donation-based crowdfunding platform.

Equity crowdfunding

With equity crowdfunding, investors get shares in your business in exchange for their investment – think Dragons' Den. They become shareholders and own part of your business.

The value of their stake in your business can go up or down, as with any investment shares. Early-stage and growing businesses often use crowdfunding.

It's a good idea to consider whether you want to give up part of your business in exchange for investment. If the answer is no, it might be better to secure investment in another way.

Crowdcube is just one example of the many equity crowdfunding platforms your business could use.

Debt crowdfunding

Debt crowdfunding (or peer-to-peer lending) is a way to secure crowdfunded loans for your business, which you then repay with interest.

It's often used by established smaller businesses that want to bypass traditional banks and lenders, or have been turned down for finance. Debt crowdfunding can offer lenders improved rates of return, while your business can benefit from reduced fees.

Examples of debt crowdfunding platforms include Funding Circle.

Which type of crowdfunding is best for my business or organisation?

This largely depends on the amount you want to raise, your plans for the funding, and which type of investor reward or incentive best suits your business goals.

For example, are you happy to give up equity in your business or would you rather retain full control and offer investors a gift instead?

You may choose to combine a number of different methods, provided the platforms you want to use will allow you to crowdfund through them if you aren't already established as a business.

Crowdfunding campaigns can be costly and time-consuming. If you don't feel you have the resources to make it a success, you might want to look at other forms of fundraising first, such as grants or loans.

How does crowdfunding work?

You'll need to register your new business or project with one or more crowdfunding platforms to start raising finance. Most platforms will vet your business to make sure you meet their rules for fundraisers.

Before registering with a crowdfunding platform, it's essential to research the different costs, rules and benefits associated with it.

For example, some platforms offer a wider range of features to help you reach more potential investors, such as tools to promote campaigns or make the most of your fundraising pages.

After you register with a crowdfunding platform, it's time to create your pitch or fundraising campaign. Most pitches include the following information:

• A summary of your business or the project you're raising finance for.

• Your funding target.

• Details of what you'll give investors in return.

• How many people have already invested.

• How much in finance you've raised so far.

• How long the pitch will be open.

• The share in your business you're offering (this only applies if you're using equity crowdfunding).

Most crowdfunding platforms allow you to register and set up a pitch for free. They usually charge fees based on the amount of finance raised, which are typically 4% to 5% of the total amount raised for your project or business via the platform.

If you don't meet your fundraising target, the money pledged is usually returned to the investors.

Advantages of using crowdfunding

• It can be a quick way to raise finance with no or low upfront fees.

• Crowdfunding platforms are an effective way to reach a large audience, including potential investors.

• It's an alternative finance option if traditional lenders have turned down your business.

• You can test whether your idea is viable and popular.

• People who invest in your business via crowdfunding will often become your customers once you launch your product or service.

Disadvantages of using crowdfunding

• The platform could refuse your application to join.

• Your business may not receive any funding if you don't meet your fundraising target.

• You'll need to invest significant time and resources to promote your crowdfunding campaign.

• It's important to protect your idea – such as with a patent or copyright – as someone could copy it after seeing it on a crowdfunding platform.

Your cultural and community space toolkit

If you're reading this guide as part of the toolkit for opening, running and growing a cultural or community space, next look at step 14: understanding debt finance.

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