With so much excitement being generated about crowdfunding, it is easy to understand how the different forms of fundraising can get confused. Debt crowdfunding, which involves lending, is what many of the major platforms are offering today. An investor pledges a certain amount for a project as a loan, and then in return, the company gets the cash and promises a product delivery in return by a certain deadline.
Equity crowdfunding, on the other hand, raises money through the offering of actual shares to a company. The business is raising capital as they would in the traditional sense, but instead of having two or three accredited investors getting a slice of the pie, they’re looking at two or three hundred investors instead.
Why Is There So Much Confusion?
It’s the very reason why Title III of the JOBS Act has likely stalled for two years. Equity crowdfunding is generally considered the same as debt fundraising. This is because the general public sees the giving of money to get an equity share the same as the giving of money to get a tangible reward in return. Rather than donation fundraising, which gives money directly without any reward or equity share, it seems to make sense that equity and debt would be considered the same.
The difference is that equity fundraising gives an investor a continuing source of potential profit. If a micro-investor decides to give a start-up $5,000 in return for a 1% stake of the company, then there’s 1% ownership of that company. They’re entitled to that amount over the course of life in that company and it is a share of the company that they can sell to someone else should they wish to do so. With debt financing, they’re simply soliciting investors for loans that they’ll pay back with a fixed amount.
Rewards crowdfunding, on the other hand, just gives you a product or a service like you would purchase at the store. Take the Coolest crowdfunding effort on Kickstarter that recently concluded with a record $13 million in funds raised. A majority of that funding came from pre-orders of the multimedia party cooler. No one is getting a piece of the Coolest corporate pie. They’re just getting a cooler instead.
Equity Crowdfunding Does Not Provide an Expected Repayment
When you sign a deal with a bank to get a loan, you’re also agreeing to a specific repayment schedule. You’re making a promise that you’ll pay a certain amount of money back every month and if you don’t, there will be financial consequences that happen. That’s essentially what debt crowdfunding happens to be. In many ways, you could call debt crowdfunding the ultimate debt consolidation loan. Instead of just one lender, however, there could be hundreds.
Either way, the investor in equity and debt crowdfunding is expecting to get a return on their money, which is different from rewards or donation crowdfunding. Instead of getting products or services, they expect to make money on their investment, either through interest on a debt or through continuing profits in a company. By understanding the differences in crowdfunding, a better investment decision can be made. Now go forth and invest.
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