Crowdfunding, investment crowdfunding, securities crowdfunding, crowdinvesting, crowdfinancing, debt crowdfunding, crowdlending or equity crowdfunding, all describe the collective effort of individuals who network and pool their resources, through traditional offline and digital online venues, to support efforts initiated by other people or organizations.
Crowdfunding also includes Peer-to-Peer Lending but some platforms have been relabeled as “Marketplace Lending” as a growing number of direct lending platforms are using institutional money or their own balance sheet to finance loans with a diminishing dependence on smaller investors. Crowdfunding is also used in support of a wide variety of activities such as online investing activities.
We are going to focus on Crowdfunding in USA so let's start with the JOBS Act, a piece of legislation that made all this possible. Let's talk now about some fundamental notions in crowdfunding.
TYPES OF INVESTORS
In the discussion of crowdfunding, there are two types of investors in the United States: accredited investors and non-accredited investors. These two groups operate by differing rules when investing. In general, if you make less than $200,000 a year or are worth less than $1 million in net worth you are a non-accredited investor, although there are more complex rules that define these two groups.
The importance of these designations and one of the reasons Crowdfunding is an emerging topic in the United States is due to the JOBS Act enabling non-accredited investors to invest in private companies via crowdfunded offerings for the first time since the 1930s. With the new rules under Titles III and IV of the JOBS Act, average American citizens can contribute capital to companies without those companies having to be listed on typical stock exchanges such as Nasdaq or NYSE.
TYPES OF Crowdfunding
Donation-based crowdfunding is a way to source money for a project by asking a large number of contributors to donate a small amount to it. Donation-based crowdfunding can also be used to raise funds for charitable causes.
Because this sort of crowdfunding is predicated on donations, funders do not obtain any rewards, ownership or rights to the project, nor do they become creditors to the project.
The only risk of donation crowdfunding is the difficulty of verifying use of funds once a contribution is made.
Debt Crowdfunding is when a group of people or businesses lend money to an individual or company with the understanding that the loan will be repaid with interest. Debt-based crowdfunding has grown rapidly as institutional capital has capitalized on the superior risk-adjusted returns generated by direct lenders. P2P lenders in some countries have re-labeled their platforms as “Marketplace Lenders” to reflect the shift from small investors to large ones. Some online direct lenders use their balance sheet to finance individual loans.
With debt crowdfunding, the main risk is a default. Every site will have their policies on default and investors should understand these policies in order to protect themselves.
Revenue-share Crowdfunding is when a group of people or businesses lend money to an individual or company with the understanding that the loan will be repaid with interest for the future revenues generated by the entity. While not as common as debt or equity models, this flavor of crowdfunding ties the contributors to the future success of the project.
With revenue-share crowdfunding, the main risk is the delay in repayment due to revenue generation problems. It is a riskier bet than debt or equity crowdfunding for the potential backers.
Rewards-based crowdfunding is where contributions are exchanged for current or future of goods or services. Individuals or companies who launch campaigns may compensate contributors with something like a t-shirt, a copy of whatever they’re building or even just a thank you.
Rewards-based crowdfunding is perhaps the most prolific form of crowdfunding currently taking place in the world. Kickstarter and Indiegogo facilitate anyone to create a webpage on their sites and pitch an idea. Specific rules on funding vary by the website.
The main risk of rewards crowdfunding is delay or non-delivery of the rewards since crowdfunding platforms do not guarantee transactions while taking all necessary measure avoid such situations.
Debt, Equity, and Revenue Share or Investment Crowdfunding
Investment crowdfunding when the crowd exchanges money for securities. There are three types of investment crowdfunding: debt-based crowdfunding, revenue-share based crowdfunding and equity based crowdfunding.
Equity crowdfunding is crowdfunding where the exchange is company equity, or ownership, and not goods or services. The idea is very similar to how common stock is bought on the stock markets however equity crowdfunding offerings have limited resale opportunities because of the private nature of the companies involved.
In the United States, there are three exemptions which allow for equity crowdfunding to occur. Titles II, III and IV of the JOBS Act provide the exemptions for public sale of private company shares to individuals. In most other countries a single exemption provides for online solicitation for exempt offerings to occur.