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 large 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. With the international networking opportunities presented by the Internet, crowdfunding has become far more convenient and accessible. The term crowdfunding first appeared in 2006 and specifically denotes joint funding carried out over the Internet.
How does crowdfunding work?
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. Money is donated to projects, causes or non-profit organizations, and backers do not expect to receive any kind of return other than participation in the cause and perhaps recognition from the donor or crowdfunding platform. Swiss crowddonating platforms are generally funded by sponsors and do not charge a commission for their services.
2. Crowdsupporting. While the term crowddonating generally refers to crowdfunding of charitable causes through donations, 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 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 crowdinvesting 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.
Another form of crowdlending involves investors making their capital available to crowdlending platforms, which then provide loans to lenders of their choice. This type of crowdlending works much like banking with the difference being that loans are private contracts between the borrower and private investors. It does not requirement a great deal of involvement on the part of investors as the platform handles the selection of borrowers, but this model is not common in Switzerland. The term peer to business lending or P2B lending is sometimes used when private investors provide business loans directly to companies.
Benefits of crowdfunding
The primary benefits of using crowdfunding platforms as opposed to seeking out investors 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 third-party bank accounts (escrow accounts, for example). 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 if recipients are able to meet certain conditions or prove that funding is used for its intended purpose. Platforms may also act as screening agents in that projects must meet certain criteria in order to be listed on the platform. The transparency which platforms provide help 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. This gives you more time to focus on the project itself and on other means of promotion. As an investor, platforms provide you with a marketplace on which you can quickly connect with investment opportunities. They handle a large part of the administration connected with private investments or loans.
4. Interaction. Many crowdfunding platforms use models which encourage engagement on the part of recipients, 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 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. These risks can only be avoided by careful selection of projects and by spreading your backing across many different projects rather than investing all of your capital in just one or two 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 rather than 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 3% of the invested amount.
3. Third party fees. Because crowdfunding platforms are primarily online-based, you generally cannot invest or donate cash. Swiss crowdfunding platforms typically allow backers to contribute via bank transfer to accounts denominated by Swiss francs, which allows for fee-free transactions. If you donate or invest via foreign crowdfunding platforms, however, you need to consider the cost of international transfers and exchange spreads. If you pay by credit card, you should consider the cost of credit card foreign transaction fees. Certain types of crowdfunding (particularly real estate crowdinvestment) may generate third party fees such as notary fees, legal fees and escrow account fees which may not be included in the platform fee.
4. Disreputable platforms. The nature of crowdfunding engenders a great deal of transparency. But as with all Internet-based applications which involve the transfer of money, it is important to exercise caution in selecting the platform you use. This is especially true if you intend to provide a platform with sensitive personal information or credit card information. 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 types and uses continue to emerge on an ongoing basis. Legal regulations have been slow in catching up. Swiss crowdfunding platforms are not classified as financial intermediaries by supervisory authority FINMA because they do not handle third-party assets. They simply provide a brokerage service while all finances are handled by regulated banks or escrow agents. The lack of regulation leaves some room for legal complications for both investors and projects.
Crowdfunding makes it easy for prospective backers and investors to connect with causes or investment opportunities on a regional, national, internationally or even global level. This opens avenues for investing and obtaining funding which were not available in the past. As with any service, you should carefully consider the reliability, fees and performance of crowdfunding platforms before you partner with them for funding, investment or financial backing.