Crowdfunding offers entrepreneurs a means of generating large sums of money quickly. It’s ideal for startups and small businesses that might otherwise struggle to get funding for projects that would make all the difference.

In this guide, we explain everything you need to know about crowdfunding and explore its potential benefits and risks.

What is crowdfunding?

Crowdfunding is a popular method of raising money to get a business off the ground or to take it to the next level. It involves presenting a business pitch that’s powerful enough to convince hundreds or thousands of people to part with a little of their money. What they get in return depends on the type of crowdfunding you have opted for. 

What are the different types of crowdfunding?

Each crowdfunding site or platform operates differently and has its own eligibility criteria. In some cases, the application process to get your crowdfunding project accepted is straightforward, for others, it’s more rigorous, with due diligence or credit report checks. 

If you have a strong case for funding, you may want to consider one of the following crowdfunding options:

Equity crowdfunding

Public investors get a stake in your business in return for their financial input, which can be as little as £10. The hundreds or thousands who part with their money do so in the hope that their investment will see the company prosper on the stock market and perhaps end up being sold for a fortune. 

Below are some of the pros and cons of using equity crowdfunding. 

Pros:

• Individual investments. This type of crowdfunding attracts people willing to invest over the longer term, with an eye on a big return if the company floats. As such, individuals can be more willing to invest larger sums

• Up-front costs. There are usually no set-up fees, making it an affordable way to raise finance 

• Loyal supporters. The long-term relationship creates an affinity between investor and company, which provides the opportunity to attract them to invest more further down the line

• Investor input. Equity crowdfunding tends to attract financially- and IT-literate people who may be willing to share their expertise or introduce your company to like-minded people via social media and work networks. It is, after all, in their interests that your company thrives

Cons:

• Less control. By offering hundreds or thousands of individuals a stake in your company, you’re relinquishing a degree of control over the future of your business 

• Missed target. If you don’t raise your funding target, the crowdfunding site may return all money pledged to the investors. This can damage your reputation, making it harder to get future investment

• Tricky questions. Prospective and current investors may want to speak with you directly about your plans or progress. This can put you under pressure to deliver the right answers, which should be consistent and realistic

• Time-consuming activities. Tricky questions aside, your investors expect regular updates and financial reports on progress that can add to your administrative load

Read more: Equity crowdfunding: everything you need to know

Debt crowdfunding

Debt crowdfunding works in the same way as a bank loan insofar as both models see a fixed sum of money borrowed for a specific period of time, with interest applied over the term. The difference is that with crowdfunding, the lender is a large group of individuals who collectively contribute the target sum set by the lender rather than one financial organisation funding the loan. This type of crowdfunding is also called peer-to-peer lending. 

Below are some of the pros and cons of using debt crowdfunding. 

Pros:

• Interest rates. Platforms typically charge lower interest rates than the borrower could get through a corporate lender, such as a bank. Rates vary depending on various factors, such as the amount you want to borrow, the loan term, your credit score and the reason for the loan

• Control. Unlike equity crowdfunding, you don’t issue shares in return for finance, so you aren’t giving up any control of your business. Once you repay the loan, your relationship with the lender ends 

• Speed. It can be quicker to meet the platform’s criteria, attract lenders and get your target loan than with a traditional lender 

Cons: 

• Missed repayments. Unlike other types of crowdfunding, you must repay the money you borrow, with interest

• Credit report damage. Failure to repay on time is likely to result in a tarnished credit report, making it harder to borrow in the future

• Asset risk. Some debt crowdfunding platforms require you to put up a business asset, such as your premises or equipment as security

Read more: What is debt funding?

Rewards crowdfunding

With this type of funding, backers provide a sum of money in return for a reward. The nature of the reward can be anything from a copy of a much-anticipated game before it hits the shops to a discount on or preview of a new product or service.

Below are some of the pros and cons of using rewards crowdfunding. 

Pros:

• Control. Unlike equity crowdfunding, the individual pledging money doesn’t gain a stake in the company

• Publicity. Rewards crowdfunding is a good way to drum up interest in a new product or service and to gauge the potential market for your offering

• Customer loyalty. This option can help foster good relations with your prospective or current customer base, encouraging them to spread the word about your business

Cons: 

• Missing the target. If you don’t hit your funding goal, the crowdfunding site may return any money that’s been donated

• Damp squib: If your product or service doesn’t live up to expectations, donors could vent their frustrations on social media and damage your reputation

• Delivery costs: You must be able to deliver the rewards, which could prove more time-consuming and costly than expected

What about donation crowdfunding?

Although the three types of crowdfunding listed above are the main ones businesses use, a fourth does exist – donations. This option is far more popular among good causes and charities, but it could attract a warm-hearted philanthropist who sees the potential in your startup or project. GoFundMe and JustGiving are examples of donation-based crowdfunding platforms.

How much does crowdfunding cost?

Crowdfunding platforms make their money by charging clients for their technology and exposure to potential investors. There are numerous different pricing structures across the 500-plus crowdfunding platforms, but here’s a flavour of some of the standard fees charged for equity crowdfunding by sites serving the UK market:

• Crowdcube charges 7% (excluding VAT) on the total amount you raise, a completion fee of 0.75% to 1.5% to cover administration costs, and variable payment processing fees, such as 0.47% for UK debit cards and 1.30% for UK credit cards

• Seedrs charges 6% on all funds raised, plus a £2,500 (excluding VAT) admin fee, plus card fees that average between 0.5% and 1.0%

• Crowdfunder charges 5% (excluding VAT) on all money raised, plus a transaction fee of 2.4% and 20p per pledge.   

How to launch a crowdfunding campaign

A crowdfunding campaign lives or dies by how successful you are at getting across your message in a way that attracts lots of people. This means putting aside time and money to achieve certain goals, including:

• Developing a persuasive argument for your crowdfunding project. To hit your target, you must win over the platforms – who would otherwise reject your application – as well as potential investors, lenders or donors

• Having a robust business plan and marketing strategy so you can get cracking as soon as you’ve raised the funds. It’s essential to have a marketing and business plan if you’re to meet your investors’ expectations and ensure you don’t miss repayments

• Reaching a wide audience. You need to make sure you have a strong and ongoing social media presence that links through to an attractive company website

• Tee-ing yourself up for return investment by keeping your investors in the loop on your progress.

• Promoting your successes online and letting the local media know. Just think of the free publicity if they cover your story