Types of crowdfunding
The Crowdfunding Centre’s May 2014 report identified two primary types of crowdfunding:
- Rewards crowdfunding, in which entrepreneurs pre-sell a product or service to launch a business concept without incurring debt or sacrificing equity/shares.
- Equity crowdfunding, in which the backer receives shares of a company, usually in its early stages, in exchange for the money pledged
Reward-based crowdfunding has been used for a wide range of purposes, including album recording and motion-picture promotion, free software development , inventions development, scientific research and civic projects.
Many characteristics of rewards-based crowdfunding, also called non-equity crowdfunding, have been identified by research studies. In rewards-based crowdfunding, funding does not rely on location. The distance between creators and investors onSellband was about 3,000 miles when the platform introduced royalty sharing. The funding for these projects is distributed unevenly, with a few projects accounting for the majority of overall funding. Additionally, funding increases as a project nears its goal, encouraging what is called “herding behavior”. Research also shows that friends and family account for a large, or even majority, portion of early fundraising. This capital may encourage subsequent funders to invest in the project. While funding does not depend on location, observation shows that funding is largely tied to the locations of traditional financing options. In reward-based crowdfunding, funders are often too hopeful about project returns and must revise expectations when returns are not met.
Equity crowdfundingis the collective effort of individuals to support efforts initiated by other people or organizations through the provision of finance in the form of equity. In the United States, legislation that is mentioned in the 2012 Jobs Act will allow for a wider pool of small investors with fewer restrictions following the implementation of the act. Unlike non-equity crowdfunding, equity crowdfunding contains heightened “information asymmetries.” The creator must not only produce the product for which they are raising capital, but also create equity through the construction of a company. Equity crowdfunding, unlike donation and rewards-based crowdfunding, involves the offer of securities which include the potential for a return on investment. Syndicates, which involve many investors following the strategy of a single lead investor, can be effective in reducing information asymmetry and in avoiding the outcome of market failure associated with equity crowdfunding.
Debt-based crowdfunding, (also known as “peer-to-peer”, “P2P”, “marketplace lending”, or “crowdlending”) arose with the founding ofZoba in the UK in 2005and in the US in 2006, with the launches ofLendingcluband Prosper Borrowers apply online, generally for free, and their application is reviewed and verified by an automated system, which also determines the borrower’s credit risk and interest rate. Investors buy securities in a fund that makes the loans to individual borrowers or bundles of borrowers. Investors make money from interest on the unsecured loans; the system operators make money by taking a percentage of the loan and a loan servicing fee. In 2009,institutional investors entered the P2P lending arena; for example in 2013, Google invested $125 million in Lending Club.In 2014 in the US, P2P lending totaled about $5 billion. In 2014 in the UK, P2P platforms lent businesses £749 million, a growth of 250% from 2012 to 2014, and lent retail customers £547 million, a growth of 108% from 2012 to 2014. In both countries in 2014, about 75% of all the money transferred through crowdfunding went through P2P platforms. Lending Club went public in December 2014 at a valuation around $9 billion.
Litigation crowdfunding allows plaintiffs or defendants to reach out to hundreds of their peers simultaneously in a semi-private and confidential manner to obtain funding, either seeking donations or providing a reward in return for funding. It also allows investors to purchase a stake in a claim they have funded, which may allow them to get back more than their investment if the case succeeds (the reward is based on the compensation received by the litigant at the end of his or her case, known as a contingent fee in the United States, a success fee in the United Kingdom, or a pactum de quota litis in many civil law systems). LexShares is a platform that allows accredited investors to invest in lawsuits.
Running alongside reward-based crowdfunding, donation-based is second another popular form of crowdfunding.Donation-based crowdfunding is the collective effort of individuals to help charitable causes.] In donation-based crowdfunding, funds are raised for religious, social environmental, or other purposes.Donors come together to create an online community around a common cause to help fund services and programs to combat a variety of issues including healthcare and community development.The major aspect of donor-based crowdfunding is that there is no reward for donating; rather, it is based on the donor’s altruistic reasoning. Ethical concerns have been raised to the increasing popularity of donation-based crowdfunding, which can be affected by fraudulent campaigns and privacy issues.