Explainer: What is crowdfunding?

If you've ever dreamed of being a part of a successful business venture, then crowdfunding may be the answer you've been looking for

Maiken Reinholdt Mogensen
May 14, 2024
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Have you ever thought about investing in a start-up or business which has built something you feel passionate about? Well, crowdfunding might be the right option for you.

In this explainer we'll be covering:

  • What is crowdfunding?
  • What types of crowdfunding are there?
  • Why do companies chose to raise money through crowdfunding?
  • Why should I become a crowdfund investor?

Let's dive right into it.

What is crowdfunding?

Fundraising is crucial for any start-up wanting to expand to new markets or develop a new product. There are different ways start ups can raise money and crowdfunding is one of them.

Usually, start-ups raise money from a mix of different entities. This can be angel investors - which are wealthy individuals (think Dragon’s Den) as well as VC’s - Venture Capital Funds (big financial institutions).

However, it’s becoming more and more popular for businesses and start-ups to also raise money from the crowd - meaning people like you and me.

Crowdfunding allows you to invest in businesses that are not yet listed on the stock exchange (photo: Female Invest)

It’s important to mention that crowdfund investing is a high risk investment. Because the fact is, the majority of early stage businesses don't make it, so returns are not guaranteed.

Facilitated through crowdfunding platforms, investors can invest in promising projects and businesses for very small amounts. But it's important to note, there are different types of crowdfunding.

Four types of crowdfunding

1. Rewards-based crowdfunding

This is when a group of individuals chose to donate money to a startup with the anticipation of receiving the business’ products or services in exchange for their contribution.

2. Donation-based crowdfunding

This type of crowdfunding can be compared to charity. Here, the group of individuals donate money with no expectations of any financial or material gain in return for the donation.

Crowdfunding is a way for start-ups to raise money

3. Peer-to-peer (P2P) lending

The third type of crowdfunding is called peer-to-peer lending. This crowdfundnig type work kind of the same way as a loan. You offer your money to the start up but you’re paid back the money you’ve invested with interest – almost like a loan from the bank.

4. Equity crowdfunding

The fourth and last type of crowdfunding is equity crowdfunding. Here, you’ll be investing your money in the start-up in exchange of ownership - equity. You will own a small part of that company. It’s comparable to how you’d buy and sell regular stock on a stock exchange. Imagine being a part of the birth of an innovative business idea and watching it grow into a thriving company. With equity crowdfunding, you have the power to make that happen.

Now the question on your lips might very well be: if I can buy a company's stocks, does that mean the company is being listed on the stock exchange?

The short answer is no.

If a company or start-up announce they are crowdfunding, it doesn’t mean they are “going public” or IPO’ing on the stock exchange.

With equity crowdfunding you buy stocks in the company

Privat companies are businesses whose ownership is private and their shares are therefore not traded publicly on the stock exchange. Traditionally, investing in private companies has been reserved for angel investors or venture capital funds, but previously mentioned crowdfunding democratizes this, by giving everyone the option to invest in the company for small amounts.

If you want to invest in an equity crowdfund, the actual purchasing of shares will happen on a different platform than where you buy your “normal” stocks from companies listed on the stock exchange.

So how do these platforms work?

Choosing a crowdfunding platform

When a company or start-up is raising money through a crowdfund it happens on a specific platform, tailored to handling crowdfund investing. Depending on where you’re based there are different platforms available. In Europe, some of the biggest crowdfunding platforms are Kickstarter, Crowdcube and Seedrs.

How does it work?

Crowdfunding platforms connects start-ups with potential crowd investors, like yourself. On the platforms, you’ll find all the different start-ups that are crowdfunding.

Here, each company will have a dedicated page where you can read all about them, why they are raising money, what projects they have in the pipeline and also all their key metrics.

As mentioned earlier, investing in a start-up through a crowdfund is considered a risky investment. But that doesn’t mean it shouldn’t be part of your investment strategy.

Here are four reasons you should invest in a crowdfund

  1. You get the opportunity to invest in startups that are not yet publicly listed.
  2. You can support companies with a mission or product that you believe in
  3. You can diversify your portfolio by spreading your investments.
  4. You get the chance of much bigger returns. Risk and return often go hand it hand. The higher the risk, the higher the chance for a bigger return. However, there’s no guarantee.

Is crowdfunding for me?

That's a good question.

Before diving into any investment, it's crucial to take a step back and evaluate your financial situation. Even though crowdfund investments typically don't require a lot of money, ask yourself: can you comfortably afford to lose the money you’re putting in?

Investing in crowdfunding also requires patience and a long-term outlook. But it’s also important to note that there are no guarantees, and the majority of start-ups don't make it. So you need to be fully informed about the business you're considering investing in.

Tips for crowdfunding success

1. Invest in something you believe in

Like all other investing, it's important that you take a moment to consider what type of business you want to support. When browsing through the crowdfunding websites ask yourself: is this company aligned with my personal values? Will I feel proud knowing I've invested my money in this company?

2. Tax considerations

Depending on the country, there may be some tax considerations to know about and take advantage of. This will often be stated on the crowdfunding platform you chose.

3. Get to know the company

It’s important to make sure that you’re giving your hard-earned cash to a company you believe in. Similar to other investments, you’ll need to do your own research and look into their business model, profits, and debts to get a better understanding of the business and whether or not it's a good investment.

4. Be an active investor

Even though crowdfunding projects can take a while to see returns, it's important to remain engaged and continue spreading the word. You put your money into these companies for a reason - perhaps it was the product or service they offer, or maybe you believe in the people behind the scenes. Take an active role in supporting these businesses. Stay updated on their progress and share news of their success with others. By becoming a champion for these companies, you are not only investing in their future, but also in your own. 

Want to know more about crowdfunding and how you can get started? Check out our in depth course on crowdfunding.


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