Crowdfunding in the United States started around 1997 and have slowly evolved together with the securities and exchange regulations. The two early types of crowdfunding have been in the form of donation and rewards-based crowdfunding. With the new legislations, equity and debt-based crowdfunding have started to increase in popularity. Although they are all under the same umbrella term “crowdfunding” each type is significantly different and we will try to shed some light by explaining each one of them.
- Rewards-based crowdfunding
|This is the most common type of crowdfunding with two popular rewards-based crowdfunding platforms Indiegogo and Kickstarter. ‘Backers’ pledge amounts ranging between $1 and $5,000 in exchange for a reward. Each pledge amount corresponds to a different reward, for smaller amounts it can be in the form of a thank you note or a t-shirt whereas for larger amounts it is usually the product.|
Rewards campaigns typically last less than three months and tend to work well for consumer, tangible products who require less than $100,000 in funding. The benefits for the backers are usually in the form of product discount as well as bragging rights which comes with being the first to have a really cool product.
- Donation-based crowdfunding
Campaigns collect donations without being required to provide anything in return to the donor. This type of crowdfunding is typically used to raise money for a non-profit or a cause. Some donation-based crowdfunding platforms focuses on third-world countries or healthcare.
A tax deduction is possible only if the money is raised by a non-profit organization also known as 501(c)3, donations to non-registered 501(c)3s and individuals are not tax deductible. For the donors, the reward is in the form of gratitude from the fundraiser or beneficiary and the feel good of doing something good with the possibility of some 'Good Karma' in the future.
- Equity crowdfunding
|Under equity crowdfunding, the average amount tends to be larger. However, the investors do not receive a reward but a piece of equity in the private company. Typically, the startup needs to set the investment terms such as the valuation cap, ownership percentage and discount percentage. Companies tend to raise money to fund the launch or growth of a company.|
Investors are usually looking to gamble some money in the hope that they might have a huge acquisition or public offering.
- Debt crowdfunding
Lenders and investors tend to be used interchangeably for debt crowdfunding campaigns. Unlike the other forms there is no exchange of rewards or equity. This is popular amongst entrepreneurs who already have revenue so they can support the payments to the investors and they do not want to give up ownership of their company.
The investor makes a loan to the company with the expectation to get paid back the principal plus interest.
- Revenue sharing crowdfunding
|Revenue sharing has been around for many decades with its major application being in the gas, mineral and music industry. It is a new form of crowdfunding that has emerged in recent years and has been particularly interesting for companies that have revenue but do not have a clear path to get acquired or to go for Initial Public Offering.|
The investor is looking to make a return which is based on either a cap duration or a cap investment multiple. The faster the company grows, the faster the investor gets paid back and the higher will be his rate of return.