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Alternative Finance: The Four Types Of Crowdfunding

Posted 9 months ago

Alternative Finance: The Four Types Of Crowdfunding
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Alternative investment is generally considered an investment that is not from a bank or mainstream regulated investment provider.

Alternative financial investments can be very lucrative, however are considered high risk as your money isn’t protected under the FSCS. The provider will commonly use other types of security to provide comfort for the investor and each organisation has a different means to do that, from asset-backed property investments to insurance policies.

Industries and investment products under the alternative umbrella can be regulated or unregulated. Alternative investments have become extremely popular over the last number of years and are seen by seasoned investors as a essential diversification to their portfolio.

As there are risks to consider, every alternative investment should be looked at independently, along with its annual net return verses the security given by the provider. Like with all investments, avoiding scams and get-rich-quick products means finding genuine investment products that have a better chance of prospering.

Alternative investments in 2023

 Alternative investments have included property, commodities, derivatives, hedge funds, with the newer trends being P2P (Peer-to-peer) Lending aka Debt Crowdfunding and Equity Crowdfunding. Even owning a business is considered an alternative investment in 2023.

 Professional alternative investment providers, regulated or unregulated, follow stringent compliance procedures. If for example the alternative opportunity is a Loan Note investment, the investor should be pre-qualified to meet the criteria, namely self-certified as a Sophisticated investor or a HNWI. If the investor is not experienced enough to understand the investment and all its associated risks, then the product is not suitable for them. These fundamental compliance rules are in place to protect the investor.

The four types of crowdfunding

 There are four main types of successful crowdfunding. They all share the same principles.

They provide a great solution for charities, businesses or people looking to raise capital for a cause, company or project, and in turn provide varying benefits for the investor or pledgee, depending on the type:

Rewards-based crowdfunding: backers give money to a project in exchange for a reward, e.g. a product or a service.

Debt-based crowdfunding: investors loan money to a company with the expectation of their initial capital paid back plus annual interest.

Donation-based crowdfunding: donors give money altruistically in exchange for gratitude and supporting a cause, charity or business they believe in.

Equity-based crowdfunding: investors invest money in a company in exchange for shares in that company.

Rewards-based crowdfunding

Reward crowdfunding starts with an idea that needs funding. These ideas may come from artists, entrepreneurs, founders, inventors, or film directors.

Essentially, a ‘crowd’ of people are being welcomed to pledge money against an ‘idea’, namely a product or project, so it can be made, produced, or launched. Often the pledgee will see this as a way of buying a product at a cheaper price, before a full market launch, and the project owner (i.e., inventor) will see this as their first market test of their product.

The project categories are rather broad and commonly include arts, design & tech, film, food, games, music and publishing. Naturally, pledgees tend to back items of interest to them, so backing can be as varied as helping make a new TV series to the manufacture of a new chocolate bar.

Via a crowd-funding platform, a project is listed, and a goal amount is set, by the project owner, to bring their project to fruition. Supporters can then pledge the monetary amount they wish and in due course hope to receive the ‘reward’ stipulated. This reward could be the ‘product’ itself, a T-shirt, a new drone, a watch, an album, a DVD of a film, or even the chocolate bar.

Globally, Kickstarter and Indiegogo (some country limitations apply) are the two biggest platforms for rewards-based crowdfunding. And in the UK, Crowdfunder is the largest. Internationally, there are many platforms to choose from and reward crowdfunding has launched thousands of projects, products, and events. Two success stories among many have been the Pebble smartwatch which raised $20 million and the Con Man comedy TV series which raised $2.4 million.

Debt-based crowdfunding

Debt-based crowdfunding is also known as Peer-to-Peer Crowdfunding, P2P Lending and Debt Lending. Debt crowdfunding can be an attractive option for investors seeking interest on their investment.

For a company that needs to raise capital for a specific project, debt financing is a great option. It is essentially borrowing smaller amounts from multiple people to achieve the target raise it needs. The biggest business lender in the UK market is Funding Circle, but there are many others, with some specialising in certain markets, from property, land, cars and boats to business and personal loans.

Unlike other forms of crowdfunding, it is not an exchange for a reward or equity, but a loan.

A company will invite pre-qualified investors to lend money for a project or projects in exchange for a debt instrument that pays fixed or variable rates of interest per annum. Interest will either be rolled up and paid at the end of the loan term or paid monthly, quarterly, bi-annually or annually depending on the structure.

Debt Crowdfunding is very popular in the property industry, for example a new development, a house renovation or buying land. The security is easy and transparent as can be a charge over the assets of the company that is issuing the debt instrument. These types of investment opportunities are generally available prior to development works taking place.

A benefit with Debt Lending is some investment providers allows the investor to take advantage of their ISA allowance via an IFISA (Innovative Finance ISA) which can be significantly tax advantageous.

Donation-based crowdfunding

Donation crowdfunding is simply making a donation to a charity, an individual or company for nothing in return. Donation-crowdfunding covers a wide range, from a party, supporting someone’s exams, sponsored runs to a family disaster, a war or a global crisis.

Donation crowdfunding is completely altruistic, your only reward is the satisfaction of helping someone, something, or a cause that you believe in.

It is one of the biggest crowdfunding revenue generators and shows that people who invest in a business through donation-based crowdfunding are not always just looking for a return on investment.

A big motivator for a lot of people is simply helping a business succeed and being a part of something special.

GoFundMe and Just Giving are two of the most popular donation-based crowdfunding platforms. Some reward-based platforms and equity-based platforms allow companies or individuals to add donation-based crowdfunding to coincide with their other campaign.

Equity-based crowdfunding

Equity crowdfunding is when a ‘crowd’ is invited to invest in an unlisted, private business (a company that is not listed on a stock market) in exchange for shares in that company.

The investor, now a shareholder, has partial ownership of that company and will profit if the company does well or is sold. Crowd investors tend to invest smaller amounts of money, the average being around £1,000. Lead investors may invest millions along with the crowd, depending on the business. They don’t receive any reward other than a stake in the company.

In a simple pre-money example, if the company was valued at £100,000 and the investor purchased 10 shares at £1,000 each, they would own 10% of the company.

Equity crowdfunding is typically used by early-stage businesses to fund their launch or to grow their company.

Many platforms are trying to differentiate themselves from their competitors, therefore there are four main types of equity investment-based crowdfunding.

  • Angel-led
  • Nominee-led
  • Direct investment-based
  • Company-based (White-label software)

All four types of crowdfunding really benefit all parties involved - even if that benefit isn’t tangible. It’s community building and allows people to be part of someone’s vision, dream and success, regardless of if the pledgee is seeking something in return. It’s allowing them to be part of something real, that they believe in.

Remember, the above is not advice, just a guide and a few tips on what to look for. It’s always good to get professional advice and carry out thorough due diligence as your capital is at risk before investing. 

Author: Nikki Dale

Disclaimer: To the best of our knowledge, the information we have provided is correct at the time of publishing. We recommend that you seek professional advice on any topic discussed. NextFin is not liable for any damages arising from the use of or inability to use this site or any material contained in it, or from any action taken as a result of using the site.

Tagged:   investment guide alternative finance debt equity crowdfunding

As seen in:

  • The Guardian
  • Financial Times
  • Yahoo! Finance
  • The Times
  • The Daily Telegraph
  • Crowdfund Insider
  • The Londond Economic
  • Reaction
  • RealBusiness