SUO | Suren Uppal Offices

The Potential of Crowdfunding: A Comprehensive Overview

INTRODUCTION

An innovative idea realises its potential as long as it is executed effectively and is backed by the requisite amount of capital. Support with respect to financing is an unparalleled challenge confronted by the startups on their journey to success.Amongst the various available funding resources, including banks and other financial institutions, venture capital funds, business angel investors, an alternative source gaining recognition as a supportive instrument to generate capital for startups is ‘Crowdfunding’.

‘Crowdfunding’ enables entrepreneurs to raise capital from a large pool of investors in small amounts rather than securing the requisite capital wholly from one source. It has gained traction in the last decade with varied regulations globally. Through this article, an attempt is made to provide an insight into the concept of crowdfunding, and understanding its real potential.

To further strengthen our understanding on the concept of crowdfunding, let’s begin with understanding ‘what advantages does crowdfunding provide?’

WHY CROWDFUNDING?

Crowdfunding is challenging the stereotypical financing resources and rightfully so, it offers a wide array of advantages which makes it an attractive option to be considered by entrepreneurs for their business projects, which are;

  • Convenient Access to Capital: Crowdfunding provides a platform to raise adequate capital to the businesses and overcome the obstacle of complex financing models or securing insufficient funding.
  • Flexibility: It ensures flexibility with multiple kinds of crowdfunding approaches the business can choose from in accordance to the nature of project and requirements. It especially helps the startups with the bandwidth to avoid financing pitfalls and instead go for a tailormade approach.
  • Builds Customer Base: Crowdfunding provides a head-start at building a community of customers for a new entrepreneurial venture, thereby establishing goodwill, repetitive and loyal customers.
  • Market Validation: Crowdfunding campaigns provide an opportunity to businesses to showcase their innovative ideas, test the products or services offered and pre-sell them to real-time customers. This further assists in assessing market demand, feedback, and the future investment prospects.
  • Retention of Equity: It is one of the major advantages of crowdfunding and one of the core reasons why entrepreneurs go for this route instead of the conventional ways of financing. In case of equity-based approach and the fundraisers are most likely to dilute less equity contrary to the standard financing methods. Also, in case of other kinds of crowdfunding, as explained in the article above it involves no dilution of equity.
  • Expansion of Network: Crowdfunding campaigns are a great opportunity for the fundraisers to expand their networks and connections with the investors and industry leaders. This further enhances the visibility of the business and thus enables to gain more traction.

All these advantages collectively make crowdfunding an attractive stream for the businesses today.

Having a fair comprehension of these, let’s now further delve into ‘the different kinds of crowdfunding’ and the distinct benefits offered by them;

KINDS OF CROWDFUNDING

It can be categorized into four main kinds which the fundraisers can opt for, depending upon their varied needs and requirements, these are listed below;

  • Reward Based Crowdfunding: It allows the investors to contribute funds to the business project in exchange for a ‘reward or service’ which is what the company provides and basically entails a ‘non-financial reward’. This kind of crowdfunding is leveraged by companies which are in pursuit of developing a new product or service and require funding for that purpose itself. Rewards based approach puts the company in an advantageous position with respect to no equity dilution, assessment of market by pre-selling the product/service offered andgarnering publicity.
  • Equity Based Crowdfunding: It involves sale of stake in the business ownership in exchange of the investor’s contribution. The aim of this approach is to raise a significant amount of capital in smaller proportions from a large pool of investors and is primarily used by startups which have a high growth potential. It is also known as regulation crowdfunding as a high degree of complex regulations are attached to the same. Equity based crowdfunding approach offers various set of benefits to the company including ability to raise a large amount of capital at once, long-term connections with the investors, and access to valuable expertise and network of investors, especially for early-stage startups.
  • Debt Based Crowdfunding:It operates along the same lines as that of the traditional financing approach from banks or other financial institutions. Also known as ‘peer to peer lending’ the investors here agree to contribute funds to the business in exchange of a promise that the money be repaid along with a pre-determined interest rate over a fixed period of time. Debt based approach is beneficial to the business as it ensures retention of ownership, no obligation towards the end of repayment of debt to the investors, accelerated processing in comparison to the traditional banks loans with less cumbersome procedures involved, a specified repayment schedulefurther eases the planning for future investments and is usually cheaper than other exorbitant means of loans and financing alternatives.
  • Donation Based Crowdfunding:In case of this method, investors ‘donate’ money in with no involvement of financial returns. Donation based approach is popularly used in order to stimulate awareness or for a social cause. This method is largely based upon the premise of ‘for the greater good’. It provides an edge to fundraisers as it entails no repayment obligations, contributes towards the community welfare thereby, provides a platform for community building as well.

Here, we observed the purpose and the different set of advantages that each one of them holds, guiding us as to which one would be better suited for our business subject to the varied requirements.

Now that we a clear picture on the overall concept of crowdfunding, let’s walk through some of the successful companies which leveraged crowdfunding on their journey to success;

SUCCESS STORIES

These companies ditched the orthodox approach and embraced the dynamism of crowdfunding;

  • Oculus VR: It remains one of the biggest success stories of crowdfunding with a campaign which started in the year 2012, and towards the end had over 9500 investors which raised more than $2.4 Million.
  • BrewDog:  A Scottish unicorn, that exploited equity-based crowdfunding in the year 2011 on the website Crowdcube. It was successful in raising £ 126 Million through the campaign.
  • MVMT Watches: It is one of the most successful crowdfunded businesses which started a crowdfunding campaign on the website Indiegogo and managed to raise $300,000 backed by over 3850 investors

These examples of successful companies provide us with a real time picture of the potential of crowdfunding. Over the last decade, it has had a profound impact on the growth of a lot of successful business ventures and showcases a strong character in the future as well.

CONCLUSION

In this age of digitization, crowdfunding is now on a strong footing and competes with the orthodox financing approaches which often pose a challenge of adequate funding to the startups. These online platforms have had a major share in giving a direction to especially startups and ensuring they are backed by the requisite support. It offers a range of advantages including enhanced visibility, less complexities, market analysis, access to funding and networking opportunities to the businesses. It must be ensured that regulations are duly followed and the campaign selected fills in all the necessities of the venture and proves to be the right fit for the same. This article is an attempt to provide an overview on the overall concept, including the need for crowdfunding, various kinds of crowdfunding to choose from and the companies which have made a mark leveraging this new age funding method. Today, crowdfunding is an instrument which is as powerful as other contemporary financial tools, sure, it has certain challenges that come along as well; however, a critical analysis will certainly help in finding an appropriate opportunity for the startups. Winding up, as technology evolves, these online platforms prove to be a viable alternative to secure funding for the businesses.

Authored by:

Adv. Nemat Budhiraja,

SUO Law

SUO