The potential and pitfalls of crowdfunding

Few businesses will be able to go from seed to market without access to additional finance, so businesses often need to seek investment to scale up operations. Crowdfunding has emerged as a popular and flexible funding solution for many companies, who otherwise may have struggled to access traditional finance options.

Before embarking on a crowdfunding campaign businesses should be aware of the different types of crowdfunding and their potential pitfalls.

There are three main models. The most straightforward option is the donation model whereby money is donated towards a campaign. The investor’s motivation is charitable and there is no return to the donator.

Secondly, and probably the most recognisable type of crowdfunding, is the reward-based model. This is where the crowd makes a monetary pledge to a project and receives something in return. The reward could be merchandise or a discount on future purchases and can be structured on a sliding scale depending on the amount pledged. Companies adopting this model should think about the future viability of the rewards offered and build these costs into their funding considerations.

Finally there is the equity model, which is the most complex model of crowdfunding. Investors are offered shares (equity) in the company in return for their investment. Equity crowdfunding platforms will usually run an “all or nothing” approach. If the business fails to meet the target amount then the investment will not take place.

Before embarking on this model of crowdfunding, companies will need detailed financial forecasts and have prepared a value proposition and pitch video. Companies should also consider seeking corporate legal advice on important issues such as investment share rights and ensuring that the company’s current constitutional legal documentation will allow the planned investment to take place.

Crowdfunding can be a flexible way for a business to raise funds, validate a potential market and test customer receptiveness. But companies considering crowdfunding should always consider the limitations of each model and where necessary seek specialist legal advice.

If you have questions about anything covered in this article, please do not hesitate to get in touch with our Start-ups Team.

Note: the content of this article is for general information only and does not constitute legal advice. Specific legal advice should be taken in any specific circumstance.