If you have ever contributed club fees, joined a party of friends in funding a pal’s new business venture, paid taxes or donated money to a social cause, community project or political party, you have engaged in crowdfunding. Crowdfunding is nothing more than the joint financing of any kind of project by a group of individuals.
In the past, this form of financing was carried out primarily within physical communities or on an individual basis between acquaintances. A person with a bright idea had to solicit financing through direct contact with potential donors or investors, or through printed media, radio or television. The international networking opportunities presented by the Internet have made crowdfunding far more convenient and accessible. The term crowdfunding was first used to describe joint funding carried out over the Internet in 2006.
Types of crowdfunding
Crowdfunding is a broad term which covers a number of different activities including:
1. Crowddonating. In this form of crowdfunding, individuals and other legal entities show their support for a charitable cause by donating money via online platforms. Swiss crowddonating platforms are generally funded by sponsors and do not charge a commission for their services.
2. Crowdsupporting. The term crowdsupporting refers to the practice of donating to projects which could potentially turn a profit. Inventors, musicians, artisans, entrepreneurs, social businesses or small and medium-sized businesses can use crowdsupporting platforms to appeal to backers who are willing to support their ideas through donations. Swiss crowdsupporting platforms typically charge recipients a fee (6% of collected donations, for example).
3. Crowdinvestment. This form of crowdfunding connects small and medium-sized enterprises, entrepreneurs and startups with investors who are looking for returns on their investments. You can find detailed information about the investment models, benefits and risks of this type of crowdfunding in the moneyland.ch guide to crowdinvestment. In Switzerland, crowdinvestment is often used as a means of funding joint purchases of real estate (refer to the moneyland.ch guide to real estate crowdinvestment for detailed information).
4. Crowdlending. This type of crowdfunding involves the direct provision of loans to individuals or businesses by private investors. It is commonly referred to as peer to peer lending or P2P lending. In crowdlending, multiple investors provide private loans to a borrower. Peer to peer loan platforms may allow borrowers to choose how much interest they are willing to pay, within limits. Investors can then invest in the loans of their choice. You can find useful information about peer to peer lending in Switzerland in the moneyland.ch guide to peer to peer lending and the moneyland.ch guide to peer to peer loans.
5. Initial coin offerings (ICOs). This type of crowdfunding is primarily employed by companies developing blockchain-based products. The company seeking to raise funding sells blockchain tokens to investors. If their product is successful, demand for their token may increase because the supply of tokens is limited and the tokens are required in order to use the product. If that happens, investors can sell their tokens on the secondary market – ideally for a profit. The moneyland.ch guide to ICOs provides useful information on this type of crowdfunding.
Advantages of crowdfunding
The primary benefits of using crowdfunding platforms as opposed to seeking out investors or investments on your own are:
1. Broader reach. Many crowdfunding platforms consistently invest in marketing and thus generate far more traffic than most people would attract to a personal website, social media page or blog. Individuals looking for a charitable cause or business venture to invest in will often use crowdfunding platforms as a first stop for finding projects which interest them.
2. Trust. Crowdfunding platforms typically hold money collected for projects in escrow accounts managed by third-party banks. If fundraising targets are not reached (a deadline normally applies), money is returned to backers. If targets are reached, money is passed on to recipients. Some platforms (particularly crowdinvestment platforms) only pass on funding to recipients if they are able to meet certain conditions or prove that funding is being used for its intended purpose. Typcially, platforms also act as screening agents by requiring that projects meet certain criteria in order to be listed on the platform. The transparency which platforms provide helps to engender trust between projects and potential backers who may otherwise be hesitant to invest or donate money.
3. Time savings. As a project initiator, carrying out a fundraising campaign on your own requires time and effort. Crowdfunding platforms facilitate the collection and transfer of funds and provide a platform on which you can promote your project in a format which can easily be broadcasted via social media. While promoting your project through your own networks is still crucial to achieving your fundraising goals, using crowdfunding platforms removes a great deal of the administrative work. As an investor, platforms provide you with a marketplace on which you can quickly connect with investment opportunities. They also handle a large part of the administrative work associated with making private investments or loans.
4. Interaction. Many crowdfunding platforms use models which encourage engagement on the part of projects, backers and potential backers. For example, almost all platforms clearly indicate how much has been raised towards projects at any given time. Most allow backers to have their profile displayed alongside their investments or donations and to share this with their networks, encouraging other parties to donate or invest. Many platforms require projects to post regular updates and allow users and recipients to comment on projects, which engenders transparency.
Disadvantages of crowdfunding
While there are few real disadvantages to crowdfunding in itself, there are costs and risks associated with certain types of crowdfunding.
1. Risk of loss. In crowddonating and crowdsupporting, there is a risk of funds being misappropriated by recipients. Crowdinvesting and crowdlending normally involves the creation of legally binding contracts so that investors can claim returns. However, there is the risk of businesses failing to turn a profit or of borrowers defaulting on their loans. The due diligence and the capital and reporting requirements of crowdfunding platforms are typically less stringent than those of stock exchanges. For this reason, crowdinvesting carries a higher level of risk than investing in exchange-listed stocks. These risks can only be avoided by careful selection of projects and by spreading your investment capital across many different projects.
2. Platform fees. Fees charged by crowdfunding platforms can pose a significant cost, and this cost becomes more noticeable when larger amounts of money flow through crowdfunding channels. If, for example, a startup collects 1 million Swiss francs in investment on a platform which charges a fee equal to 6% of invested capital, that startup will pay 60,000 francs in fees. In the case of real estate crowdinvestment, platform fees are typically charged to investors and not to property developers or sellers. An investor who commits 50,000 francs to crowdinvest in a 2-million-franc down payment on an apartment house will pay a 1500-franc platform fee if the platform fee is equal to 3% of the invested amount.
3. Third party fees. When investing, lending or sponsoring through online platforms, make sure to account for expenses such as bank transfer fees, exchange rate spreads, credit card foreign transaction fees and other incidental fees which may not be covered by the platform fee.
4. Disreputable platforms. The nature of crowdfunding engenders a great deal of transparency. But as with all online services, there are a number of disreputable or even fraudulent crowdfunding platforms on the Internet. Always take the time to research the location, status and management of the company which runs the platform. Reputable platforms should have physical offices which can be contacted in person or over the telephone.
5. Poor regulation. Crowdfunding is a relatively recent phenomenon and new uses continue to emerge on an ongoing basis. Legal regulations have been slow in catching up. Swiss financial regulatory authority FINMA has been quick in publishing initial guidelines. Swiss companies which develop crowdfunding platforms must determine whether or not they require a FINMA license before they commence operations. Platforms operated by companies domiciled outside of Switzerland may or may not be subject to similar regulations. In some countries, platform operators may accept and handle money with little or not supervision from any authority. Be sure to do your homework and understand the jurisdictions which platforms fall under.
Crowdfunding opens avenues for investing and obtaining funding which were not available in the past. As with any financial service, you should carefully consider the reliability, fees and performance of crowdfunding platforms before you partner with them for funding, investment or financial backing.