Understanding the Concept of Crowd funding in the financial sector

Understanding the Concept of Crowdfunding in the financial sector

Crowdfunding can also be called crowd financing, equity crowdfunding, crowd equity, crowd-sourced fundraising, is an attempt of raising capital from a large number of individuals via any stated means to cater to some result in or efforts started by other people or organizations. Crowdfunding is a fantastic way of helping a wide variety of activities like catastrophe relief, support of artists by followers, political promotions, new venture Company funding, free software advancement, inventions, scientific research, and civic projects or anything else.

Understanding the Concept of Crowd funding in the financial sector
Understanding the Concept of Crowd funding in the financial sector

To put it right, crowdfunding is referred to as the collection of funds via small efforts from a lot of parties to finance a particular venture or project.

Crowdfunding

In the same way, the term suggests, crowdfunding is a way accustomed to raising money by merely requesting a multitude of people to each split in a small amount of money towards a particular cause or project such as disaster control, political activities, civic projects and Start-up Company funding among others. This type of financing employs the use of the internet whereby a person trying to obtain funds for a particular cause or project sets up a webpage where they put up a profile for their cause and attempts to get people or mainly through social media to contribute towards the stated cause or project. Crowdfunding is not only restricted to individuals as companies also use it to obtain funds through the sale of minimal amounts of equity to various investors.

Types of crowdfunding

Debt crowdfunding

This type of financing also referred to as peer financing which involves getting people to put their money into a project or as a form of a loan with the guarantee of getting it back with interest. However, in the case that the money is lent to Developing Countries, it is usually paid back without any interest with the financier becoming content at having completed some interpersonal good.

Donation or Reward crowdfunding

This primarily entails people putting their funds into a project or cause given that they have faith in it; therefore, do not expect to have anything in return. This is the most typical form of funding whereby individuals are encouraged to contribute any amount towards a given venture.

Capital crowdfunding

Within this type of financing, individuals or mainly traders put their money into a project or business enterprise in exchange for shares or a stake in the said project or venture.

Benefits of crowdfunding

Helps validate a project

With crowdfunding, individuals can also know whether their cause and project will have an impact on people or if it is a waste of time and money. They get to know this if they get a financial contribution to their project.

Exposure for a project or cause

Given that this type of funding is mostly done via the internet or online, it can help get a project to be known by not only potential investors but also potential clients and thus act as a marketing platform.

A mode of capital access

With crowdfunding, more so the reward based one, individuals can permanently get money to start up a project without necessarily getting into debts or having to give up any equity.

It also helps individuals to cushion themselves against unforeseen risks, helps one to get additional ideas for their project/cause, and is a way of marketing for a product /service before it is launched and also helps to create goodwill with potential customers.

How does crowdfunding work?

If you visit a crowdfunding site, you should be able to see an overview of the projects being pitched. You might need to enroll with the site to see the pitches, to get more details, or to invest in a project.

Some crowdfunding websites charge investors a fee, which may be a percentage of any profit they make.

If you find a project you’re interested in, you’ll need to look for more details. The business, individual or social enterprise that’s looking to raise money should tell you:

  • How much it wants to raise
  • How much it has grown so far
  • The share in the business offered
  • What the money will be used for
  • How long the pitch is open for
  • How many people have already invested?
  • What you will receive in return for investing?

The investment can only go ahead if the business raises the full amount. You should have a 14-day cooling-off period in case you change your mind.

What are the risks?

Crowdfunding is a new concept and investing in young businesses can be very risky. The main risks of investment-based crowdfunding are:

The business you invest in might go bust. Many new businesses fail in the first few years so that you could lose all your money.

The return is not guaranteed. The shares may not rise in value, and you may not receive any dividend payment and a share of the profits.

Selling the shares may be hard. The shares are generally unlisted, which means you may not be able to sell them quickly in the way you could sell shares in a big company that’s listed on the stock market.

The crowdfunding platform itself may go bust. This could mean you lose money if you’d paid the crowdfunding website, but it goes bust before your money was invested with the business.

Reducing the risks of crowdfunding investments

Only invest money you can afford to lose. You should invest no more than 10% of any money you have available for spending in any one year.

What are the tax benefits of crowdfunding?

There are two central schemes which offer tax breaks if you invest in small companies: the Enterprise Investment Scheme and the Seed Enterprise Investment Scheme

Both systems let you offset a percentage of the amount you invest against your tax bill, and any profits are free of tax. But there are conditions; for example, you must keep your investment for a minimum time.


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