Crowdfunding has become an increasingly popular form of funding for entrepreneurs with a good business plan, or early stage companies looking to take their business to the next stage of its development. In the UK, crowdfunding is well established and regulated by the Financial Conduct Authority (FCA). In this article, we will explore the landscape, and look at the pros and cons of using crowdfunding as a financial tool for a business starting out, or growing.
What is crowdfunding?
Crowdfunding is a way of raising money through the collection of contributions from investors through a crowdfunding platform. Examples include Indiegogo, FundRazr, GoFundMe, Fundable, Crowdcube and Kickstarter. Those who contribute generally get something in return, such as a discount on a product, or a share in company, or its profits.
Crowdfunding has been around since 2001 but became more popular after 2012 with the launch of Fundable. It is now seen as a realistic alternative to traditional forms of funding. Most crowdfunding platforms take a fee of some sort, although many utilise an all-or-nothing funding model, whereby if a target is reached, the company gets the funds; if it’s unsuccessful, investors have their money refunded.
Types of crowdfunding
There are a growing range of crowdfunding options, including:
Peer-to-peer lending – This is very similar to traditional business loan and lenders get their money back with interest.
Donation-based – People donate for ethical reasons, but usually receive nothing in return.
Rewards-based – Investors receive goods or services in exchange for funds. Kickstarter is a good example, with different tiers of awards depending on the value of the investment.
Equity – Investors buy shares in the company. It’s vital that businesses looking to choose this option seek sound legal advice, as contracts will need to be negotiated and drawn up.
Profit-sharing – As the name suggest, investors share in the profits/revenue of the business.
Hybrid – A combination of different crowdfunding models.
The most obvious benefits of crowdfunding is access to the capital needed for the business, but there are other benefits for companies looking to go down the crowdfunding route:
Market validation – A successful campaign validates the viability of a product or service.
Create a customer base – As investors are already interested in the business and learn more, it’s likely that some will become its first customers.
Brand exposure – Crowdfunding campaigns can be an excellent marketing tool, leading to further investments from traditional sources, increased brand awareness and other PR opportunities.
Investor relations – Crowdfunding can lead to long term, beneficial relationships with business professionals offering access to expertise, mentoring and networking opportunities.
Ideal for those with a poor credit history – Because many types of crowdfunding require no credit checks, they are an ideal alternative to traditional funding for those with a poor credit score.
Most funding options come with downsides and risks. Here are some you may encounter with crowdfunding:
High fees – Crowdfunding platforms typically charge a percentage on the amount raised. When raising a large amount of money, this can mean significant fees – in some cases as much as 10%.
Loss of control – On some crowdfunding platforms investors get a say in the direction and strategy of the business. This can be beneficial, but it can also lead to conflicts.
Time and effort – Setting up and running a crowdfunding initiative can take time and diverts manpower and other resources from core business activities.
IP risk – While advertising your business early on is good, it does carry risk for your intellectual property, as you’re exposing your idea to potential competitors. Again, for this reason, it’s important seek advice first from an commercial solicitor with experience in IP protection.
Get legal advice to avoid pitfalls
In the UK, while crowdfunding offers a real funding opportunity, it is highly regulated by the FCA and businesses should be aware of all the legal considerations, including intellectual property, contractual obligations and regulatory compliance, before going down the crowdfunding route. This means getting professional legal advice from the outset from a firm of commercial solicitors such as JPP Law. If you would like to discuss the legal aspect of your business fundraising plans please book an introductory call.