Crowdfunding has become incredibly popular in the last few years.
It is predicted that by 2026 the total global crowdfunding market will be an enormous 39.8 billion dollars.
In this article, we seek to unwrap some of the mystery around crowdfunding and set out some of the key risks that you should be aware of.
How does crowdfunding work?
Crowdfunding usually takes place on a website platform that allows businesses or individuals to raise money, and investors to provide that money. The business or individual sets out their project in a ‘pitch-deck’ to attract investment (which can be in the form of a subscription for shares or a loan) from both institutional investors (companies that specialise in investment) and ‘retail investors’ – every-day people, in layman’s terms. Think “Dragon’s Den”, with a lot more Dragons.
Benefits of crowdfunding for companies
Wide pool of investors
Crowdfunding offers access to a wide pool of people with various experience and sector expertise. These individuals are often engaged investors. They are genuinely interested in the company’s ventures as the company’s venture moves forward. The investors from the crowdfunding campaign may stay involved and become more likely to invest in future ventures.
Crowdfunding can be an excellent tool to create brand awareness and raise the profile of the company. Platforms such as Seedrs and Crowdcube provide (a) a platform for the company to reach thousands of investors, and (b) facilitate the publicising of a funding round over social media and direct traffic straight to its website.
Brands in the retail and consumer space often do particularly well out of crowdfunding platforms as they are able to market (and negotiate subscriptions) directly with their client base.
Using crowdfunding platforms can alleviate many of the administrative and regulatory burdens involved with negotiating with investors. Most crowdfunding platforms take care of most of the administrative tasks involved in raising capital (albeit usually at the price of a fee) which can result in a quicker way to raise capital.
Risks of crowdfunding
The result of having a wide pool of investors is that a Company’s cap table can become overloaded with infinitesimally small percentages of shareholdings as hundreds of consumers subscribe for shares. To mitigate this problem, crowdfunding platforms use a ‘nominee structure’, whereby the nominee holds legal title to the shares for the benefit of another person.
Although this arrangement is great from an administrative perspective, it can be expensive. Some crowdfunding platforms charge for the arrangement, and is an additional cost for investee companies on top of the commissions and existing charges of presenting on the platform.
Loss of funding if undersubscribed
When the venture is presented on a crowdfunding network, the investee company decides its own fundraising target. However, if a company fails to attract interest and does not hit its minimum target amount, the company may not receive any of the investment. When this happens, the company will still be hit with some of the costs of the platform provider. This can be a very expensive and unsuccessful, exercise!
Fundraising platforms are able to promise their customers different rights. However, be aware that the interests of the platform and the investors will not always align with those of your company. For example. it is not uncommon for an investment platform to ask for an entrenched right to participate in future funding rounds. This is fine in theory, but it can add significant time and cost burden for the company when the time comes to seek future funding.
Key takeaway: Before a company chooses to move forward with a crowdfunding campaign, they should make sure they are at the right stage in their company lifecycle.
If you think your product is right for an investment platform, we recommend you talk with a number of the platform providers to see which platform is the right fit for you. We would also recommend you engage with lawyers at an early stage to ensure you are fully aware of the terms you’re signing up to!
We would be happy to assist with any questions you may have or if you would like to start your own crowdfunding round, please get in touch with us.