This article was first published in March 2017 and has been edited and updated for accuracy and clarity. Edited by Anis Shakirah Mohd Muslimin.
You have probably heard of crowdfunding before, but have you considered using it to fructify your savings?
Before getting into the details, bear in mind that there are many types of platforms, each for a specific purpose: donation, reward, equity and peer-to-peer (P2P) financing.
Which type of crowdfunding suits you better?
In simple terms, crowdfunding is a way that enables masses of contributors to contribute sums of money to charity, profitable projects, or to own a portion of a company.
Crowdfunding has gained traction since 2012 with a rocketing growth rate of more than 200% per year in terms of funds raised worldwide (from $2.7 billion in 2012 to $34.4 billion in 2015).
Leading market research firm IMARC Group expects the global crowdfunding market to grow at a CAGR of around 17% from 2021 to 2026.
Generally, there are four types of crowdfunding platforms: Lending-based, donation-based, reward-based and equity-based crowdfunding.
As their name suggests, both reward-based and donation crowdfunding concepts do not yield monetary returns on funds contributed. However, the reward-based model will reward investors with gifts from project owners or they get to use the product for free, in exchange for their support.
Rewards-based crowdfunding emerged as an alternative model to finance creative ideas by individuals by collecting small amounts from a large crowd of supporters (also called backers) who believe in the success of these ideas. Typically, up and coming artists can be seen using this method on rewards-based crowdfunding platforms such as Patreon or Kickstarter, among others.
Despite their success, both of the aforementioned methods are not a suitable avenue for you to grow your money. But of course, they are good ways to contribute to a cause or an idea.
Lending and equity-based crowdfunding, on the other hand, are what we can call investment-based crowdfunding. And that’s what you should be focusing on in this article!
How does investment-based crowdfunding work?
People tend to associate crowdfunding with either rewards or donations. Yet, there are other types of models out there as well, and these investment-based models even offer small investors the opportunity to invest in profitable ventures, while yielding returns higher than the market (read: up to 16% per year!).
How do they work? Investment crowdfunding websites provide a platform connecting borrowers and fund seekers to potential investors.
On one hand, parties seeking funds get the opportunity to present, promote and sell their project or business. On the other hand, investors get to choose where to place/invest their funds from a wide variety of projects, sectors and businesses.
The benefit of investment crowdfunding is that it gives investors the option to diversify their risks and optimize their returns. Moreover, investment-based crowdfunding empowers small investors to decide who to lend their money to and which project to invest in, no matter how small their bids are.
Which kind of investment-based crowdfunding is more profitable?
In equity crowdfunding, investors are entitled to a share in the financed company, which are mostly start-ups and SMEs. Thereafter, investors need to wait until an exit strategy is available (either through an initial public offering (IPO), buyout etc.) to get back their principal and returns.
A continuous major point of contention is when exit strategy would happen and whether the venture will be successful. The flipside is in cases of successful buyouts, investors can see their capital multiply many folds.
Although investing via equity crowdfunding is considered high-risk, many investors, especially sophisticated investors and angel investors, take the punt in hopes of hitting it big in case the company goes for an (IPO) or buyout; and there have been many cases of such success stories. Uber, Beyond Meat, Argus, and Cyber X are just some of the many success stories that came out of equity crowdfunding on the platform OurCrowd.
In peer-to-peer (P2P) lending, lenders finance other borrowers’ needs according to their credit rating, risk profile and financing purposes. Interests are often earned on a monthly basis and depend on the creditworthiness of the person or the business financed. The main advantage of these investments, as compared to equity crowdfunding, is liquidity.
A majority of the P2P lending space is interest-based. But have you heard of interest-free P2P crowdfunding?
How does “interest-free” P2P crowdfunding work?
You may wonder how such a business model could work. This unique and relatively new model of P2P crowdfunding is currently what Ethis’ P2P platform is operating on. It uses the same concept of mainstream P2P lending but based on a profit-sharing model.
The salient feature of this type of crowdfunding allows investors to share in the performance of the projects financed instead of earning a fixed return.
Earning a profit share increases investors’ probability of gaining higher returns on their capital (Ethis provides average annual returns of up to 15%!) compared to conventional P2P crowdfunding.
See also: What is Islamic Crowdfunding?
Do I risk losing my money?
The short answer is yes. Although investment-based crowdfunding offers enticing returns, it comes at a cost, just like other types of investments such as trading in the stock market, unit trusts or purchasing a property for investment.
At the end of the day, crowdfunding platforms are just intermediaries. They are a marketplace matching those who are seeking funds with those who are willing to invest. The actual deal is between lenders/investors and borrowers/entrepreneurs.
Hence, any shortcomings from the latter’s side will directly impact the fund providers. So who the platform chooses on their platform matters.
The companies or projects open for investment on the platform varies based on the crowdfunding platform you deal with. Some platforms, like Ethis for example, focus on companies that not only have the potential to yield high returns but are also ethical and aim to create real social impact. Each platform will vet through the companies on their platform based on their internal scorecard to ensure that their business model, historical performance and values align with what the platform offers.
In a worst-case scenario, investors can see their money vanish. It is, therefore, wiser to study projects carefully, engage in due diligence before choosing where to invest. This will lower your risks and help you maximize your returns.
Investment crowdfunding is a great way to diversify your income, but it comes with a risk
Investment-based crowdfunding can be highly profitable depending on investors’ risk appetite.
At the time markets are still staggering, investment-based crowdfunding is a viable add-on to your investment portfolio.
Not only are the returns higher than the market, but the availability of transparent information on individual projects, and constant updates on a project or business, provide individuals with numerous opportunities to choose an investment based on their preference and risk profiles.
Crowdfunding is at the forefront of the financial technology revolution, and we should embrace it!
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