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How to make the most of Crowdfunding

Crowdfunding has burst onto the London scene and is here to stay.

Derek Uittenbroek from FundTheGap explains how you can the most of crowdfunding for your business.

The crowdfunding platforms out in the open today are only the tip of the iceberg, with many more budding entrepreneurs crafting the platforms of tomorrow.

Current platforms broadly fall into one or more of four categories: donation-based, reward-based, lending-based and equity-based.

How do you know which type of crowdfunding is right for your startup?

Donation-Based

Donation-based models rely on a ‘backer’ donating a sum of money towards a cause. As expected, this model lends itself best to charities and non-profit organisations looking for small amounts of funding – say up to around £5,000.

It can be a powerful source of funding but the organisation needs to have a strong cause, with potential for a large, passionate and engaged following, to successfully raise funds.

Ultimately, the ‘returns’ to backers are purely philanthropic or altruistic, meaning that if there isn’t a strong cause for people to believe in or be passionate about, it is unlikely that the campaign will gain sufficient traction.

For this reason, it can be difficult to raise funding through a donation-based model for a commercial venture.

Rewards-Based

The rewards-based model, also called the ‘pre-sales model’, usually involves backers of campaigns receiving a ‘reward’ in return for their contribution.

This can range from something as simple as a thank you email to exclusive access to a launch event, and most commonly, a prototype of a product or service – hence the pre-sales name. This is an excellent way for pre-revenue seed-stage businesses to test their concept and build an initial order book.

In most cases, if a campaign fails, it may be an indication that there is not sufficient demand for the product or that the market is not big enough – and it can also be a useful exercise in terms of gathering feedback.

When successful, it can be an excellent way to gain initial seed funding without giving away any equity.

However, entrepreneurs quite often forget the tax liabilities and fundraising costs attached to raising funds through this model, which can be substantial.

This means that entrepreneurs can fail to deliver on promises, as there is no formal governance and accountability – meaning there is very little protecting backers in the event that the entrepreneur does not honour their commitments or reward.

Lending-Based

Lending-based models, also called peer-to-peer lending, have grown rapidly recently.

The model is based around cutting out banks as middle-men, and facilitating loans directly between individuals, and/or businesses.

It can be an excellent source of debt finance for businesses, particularly as banks are reluctant to lend, and it means entrepreneurs do not have to part with equity in their business.

It can also be attractive from a backer’s point of view, as the returns can be more attractive than available through a bank or building society.

Of course it does carry greater risk as well. Lending-based models tend to be more appropriate for more mature, revenue-generating businesses – as businesses usually require at least a two year trading history and a strong credit rating in order to get favourable rates.

Equity-Based

The equity-based model is the newest kid on the block, and the least mature. As the name suggests, backers, or investors, get equity in return for their contribution.

Equity crowdfunding is an exciting space as it is democratising start-up investment by lowering the minimum investment amounts typically associated with ‘investing in start-ups’, and opening up investing to a wider audience.

It can be a great way for businesses to raise funds, without having to approach angels, venture capital firms or banks, and the terms can be more favourable. It can also be an excellent way to bring expertise into the business.

After all, if you end up with a thousand shareholders – that is a great network and support base to reach out to for help or advice.

A thousand shareholders also means a thousand people whose long-term interests are aligned with yours towards long term success, a thousand potential customers, and a thousand potential ambassadors for the business.

Equity investment is a heavily regulated space, so do your research before choosing a platform to ensure that it’s compliant and sticks to the rules.

Do your homework

The most important thing is that you do your research before setting of and submitting your pitch on a platform. Think about your short and long term objectives, consider what growth stage your business is in and whether ‘external funding’ is appropriate for you.

Derek Uittenbroek is founder and CEO of FundTheGap, an online equity fundraising platform for start-ups and small businesses looking to raise up to £2m of investment.

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