In the last decade, the business world has seen a huge number of crowdfunding success stories — from campaigns to fund million-dollar ambitious new technologies to local communities coming together to support a local pub.
With the term and the concept becoming more and more popular, it’s easy to get lost and confused by all the different types of crowdfunding available to a business, from traditional equity style campaigns to cutting edge “initial coin offerings”.
So if you’ve heard of the term, but you’re not exactly sure what it is, sit down and strap in for a SmartCompany explainer on all the different types of crowdfunding.
First, what is crowdfunding?
At its core, crowdfunding is a way for a large number of individual consumers or investors to back a project or a product by individually contributing a small amount to its funding, typically via an online platform.
As explained by ProFounder president Dana Mauriello, crowdfunding is akin to “passing around the basket at church”.
“It’s a large crowd of people being able to contribute small amounts, which in aggregate meet the financial goal organisations group or individual,” she said back in 2012.
“The reason it’s become a buzzword recently is because it’s gone online so the potential of it has expanded.”
The concept rose to prominence in the 21st century as an alternate form of funding for many early stage startups and businesses, which were looking to secure capital without having to go through the process of courting investors.
Prior to this, crowdfunding was often used by authors as a way to ensure interest for a book or other publication by registering a number of subscribers prior to the book being written.
The underlying concept of receiving a validation of concept for a project or service is one of the reasons crowdfunding continues to be so popular and successful today.
Before the advent of the internet, donation-based project funding was the most common method of crowdfunding seen, but with the rise of platforms like Kickstarter, the paradigm began to shift towards a popular form of crowdfunding, known as rewards based crowdfunding.
Rewards based crowdfunding
In 2008 and 2009, Indiegogo and Kickstarter launched, offering digital platforms that allowed early-stage businesses or individual entrepreneurs to pitch their ideas to the masses in return for a money “pledge”.
However, this pledge was more than an indication of support; it often entitled contributors to the product the funds were being raised for or some other reward based on the size of their donation. Backers would contribute often small amounts of money in return for the item being produced, usually receiving it down the line after the business had used the pledged funds to develop the item.
Some iconic products have seen success through rewards-based crowdfunding, including the popular-yet-eventually-unsuccessful Pebble watch, and the Coolest Cooler. Some not-so iconic projects have also seen success on the platform, including a $US55,000 potato salad.
Rewards based crowdfunding works best for businesses or individuals offering tangible products or services, such as video games, movies, or salad (the reward was a potato salad party). But for businesses looking to offer something else to supporters, some other forms of crowdfunding might be worth a look.
Traditionally, companies looking to raise capital have done so by raising funds from private backers, including venture capitalists, or publicly via initial public offerings. However, the rise of crowdfunding has unlocked a new way for companies to fundraise via equity crowdfunding.
Equity crowdfunding works in a similar way to rewards based crowdfunding, except instead of contributors getting a promise for a product or service, they receive a small part of a business, equal to the number of shares they buy. For this reason, contributions in equity crowdfunding are often much larger than with reward-based crowdfunding, often in the thousands of dollars.
Often the raise is to launch a company, rather than to invest in an already established business. Legislation for equity crowdfunding has passed in the United States, and Australia passed the first stage of its legislation in March this year, after two years of consultations.
The federal government’s initial equity crowdfunding arrangements excluded proprietary companies, which meant the vast majority of Australian companies were not going to have access to the crowdfunding method. This is set to change, however, after the government used its May budget to flag an amendment to open up the legislation to more users later this year.
Australian equity crowdfunding platform Equitise has been operating in New Zealand, where equity crowdfunding for startups is legislated and decided to introduce other alternate forms of investment platforms, including a recently announced platform to allow investors access to IPOs, due to the “lengthy delays” on this front in Australia.
Initial coin offerings
Initial coin offerings (ICOs) may well be considered the wild west of the crowdfunding world, existing in a yet-to-be-regulated space and facilitated through the emerging technology of the blockchain.
Blockchain enabled companies can conduct “token sales”, similar to IPOs, allowing users to contribute a certain amount of a cryptocurrency such as Bitcoin or Ethereum in return for a portion of “tokens”, which are similar to securities.
These tokens can be traded on exchanges, and they gain an intrinsic market value. The tokens are also often used to facilitate functions of the blockchain company they’re involved with, being used as rewards or incentives.
As it is an unregulated market, bodies such as the Australian Securities and Investments Commission and the US Securities and Exchange Commission SEC are undecided on the legality of ICOs, and the bleeding-edge blockchain space can cause issues, such as hackers exploiting contract bugs and draining company accounts of millions of dollars.
But with great risk comes great reward, and companies have been able to raise mind-boggling amounts of money in split seconds — literally. Browser software company Brave raised $US35 million in 30 seconds earlier this year through a token sale on the blockchain.
Tim Lea, founder of Australian blockchain startup Veredictum is in the process of planning his own token sale, or ICO, and has been in contact with ASIC, which he says don’t have a “formalised view” on the legality of ICOs in Australia.
“We’re definitely calling ours a token sale as there are many potential regulatory issues with dubbing this sort of thing an ICO, as it implies it’s an IPO but for cryptocurrency, and by the very terming it implies it has an equity component,” he told SmartCompany.
“We didn’t get a formalised view from ASIC, and we more went to them for guidance. This concept is very new for regulators, and across the globe, they’re always one step behind innovation.
“ASIC does have the sandbox and they were very accommodating, but we still have to take a very cautious approach.”
You can help us (and help yourself)
Small and medium businesses and startups have never needed credible, independent journalism and information more than now.
That’s our job at SmartCompany: to keep you informed with the news, interviews and analysis you need to manage your way through this unprecedented crisis.
Now, there’s a way you can help us keep doing this: by becoming a SmartCompany supporter.
Even a small contribution will help us to keep doing the journalism that keeps Australia’s entrepreneurs informed.