Crowdfunding (or crowd financing) is a means for an entrepreneur to present and finance a project via an internet platform. This type of financing can be seen as a particular type of mezzanine financing.
As an example, crowdfunding can allow an entrepreneur (the beneficiary of the capital) to collect contributions from many investors (the crowd) in order to finance a start up company or a given project via a simple internet platform. In return for their contributions, the investors may receive shares in the company and become silent partners. On the other hand, the entrepreneur is not required to provide the investors with the right to oversee business management. At the same time, the entrepreneur avoids having to go through long administrative financing procedures.
From the investors' point of view, the investment is only remunerated if the project is successful and the funds invested through crowdfunding are not protected against loss.
Financing through crowdfunding can be particularly interesting for the following:
- businesses or entrepreneurs who:
- have an appealing commercial business strategy or own a prototype of a promising new product but do not have the necessary capital and means to place their product on the market;
- intend to form a company;
- cannot finance their operations through traditional bank financing even though they are in a development phase;
- inventors and developers who wish to remain independent and want to place their product on the market themselves;
- investors who want to invest in a promising start-up company or in innovative projects.
The contact between the potential investor and the beneficiary of the capital is generally established through an internet platform provider who specialises in crowdfunding. The entrepreneur can publish his project on the platform in search for investors.
The beneficiary of the capital will usually set a minimum amount of contributions that are necessary for the project to be launched.
Once the amount is set, it will usually be collected through the contributions of a large number of individual investors. The risk of failure is thereby supported by the crowd of investors.
The contribution per investor may vary depending on the project and its amount may be subject to a mandatory minimum amount.
In return for his contribution to the company, the crowdfunder receives a counterpart which can take many forms such as exploitation rights, free samples or profit-sharing.
It must be noted that the contributions must be invested in the project concerned and will be reimbursed by the platform if the minimum necessary amount set is not reached. The contributions cannot be used to finance other projects. During the initial phase, the platform provider acts as a fiduciary agent between the parties.
Who can participate?
Crowd financing usually requires the participation of the following 4 parties:
- The project owner (entrepreneur and beneficiary of the capital): he is responsible for the project and must try to collect the necessary funding. The project owner has the idea but is unable to finance it or he does not wish to take the risk on his own;
- the donors of the funds (investors): the funders are the crowd of internet users who support the idea and the project and who look forward to making a good investment;
- the producer of the project (he is the project owner's service provider): the producer is usually a specialised service provider who can contribute to the physical development of the product and its launch on the market;
- the internet platform provider: he will provide the necessary infrastructure and largely contributes to the success or failure of the undertaking through his reputation and brand image.
Advantages of crowdfunding
Raising funds through crowdfunding does not impact the business's liabilities nor its solvency.
The entrepreneur does not have to grant any management oversight rights to the investors.
The investor commitment is guided by long-term motives and the business is not under pressure to succeed immediately.
As a general rule, investors cannot request any guarantees in return for their contribution.
If the project is successful, investors can expect higher than average returns.
Disadvantages of crowdfunding
Capital intensive projects, however, often experience major difficulties in collecting the necessary funding through crowd financing. These types of projects are easier to finance through classical means of financing.
On the other hand, it is generally very difficult to convince classical investors such as investment funds or professional investors through this type of platform.
Investors are only entitled to profit-sharing if the project specifically states this type of return. But in the event of insufficient profits, the investment is not remunerated. Projects which include benefits in kind are also dependent on sufficient profits.
In the event the business goes bankrupt, investors risk losing the totality of their contributions.
As a general rule and in return for the provision of a platform and other publication services, the internet platform provider receives between 5 and 10 % of the funds collected. In this case, he must carry out a number of procedures before the fundraising can begin.
The development and publication of advertising and information campaigns may also involve costs which are not to be underestimated.
Other costs also depend on the terms that have been agreed upon in return for the provision of the funds.