The notions of crowdfunding, crowdinvesting and crowdlending refer to fundraising aimed at implementing an idea. But if crowdfunding involves attracting finance for manufacturing a product, the other two terms reflect the investor’s view on such modes of financing. What is the difference between crowdinvesting, crowdfunding and crowdlending? What are the risks as well as pros and cons of each fund raising method? We’ll discuss these matters and the legal framework such investments are based on.
What is crowdfunding
Crowdfunding is the ‘collective financing’ of projects. Its concept, i.e. the idea, is published on one of the crowdfunding platforms (the most popular ones are Kickstarter, Indiegogo, Crowdfunder, Boomstarter and Planeta.ru). Any user registered on the site, can donate a certain amount to the project. He becomes an investor. A reward for his investment may be a one-off payment from the company income paid later, or the product for which the funds were collected. It may also include additional bonuses and gifts depending on the project subject matter.
Pros and cons of crowdfunding
The advantages: there are no intermediaries in fundraising and no need to pay back the investment in case of the project’s failure. There is no need to register as a sole proprietor or be an experienced entrepreneur in order to put a project on a crowdfunding platform. Financial assistance will come from the audience interested in the project and its authors as well as investors will get a prospective buyer database.
The crowdfunding drawbacks are commissions (not applicable to investors), charged by the platform, the inability to collect an amount in excess of the maximum set by the service, and no guarantees of successful project implementation.
Crowdfunding – successful and failed projects
On crowdfunding platforms, money is most often raised for technological and gaming companies.
For example, Pebble Time waterproof watches creator raised over $20 million on Kickstarter. Kingdom Death Monster 1.5 developers got $12 million on the same platform. An equal amount was raised to produce hives with an automatic honey collection mechanism from Flow Hive. Ouya gaming console collected a little less – about $ 8.5 million.
But not all projects succeed in crowdfunding, of course. For example, the Kickended ‘museum’ displays over 8,000 projects that collected as much as zero dollars. Among them are ambitious ones of clothes expressing their owner’s emotions, books, mobile games and cases for pharmaceuticals. They failed to raise funds because they didn’t offer a structured and clear description, a ‘motivational message’ or an explanation of why investors should choose their particular project to invest money.
What is crowdinvesting
Equity crowdfunding or crowd investing is an investment in start-ups and small-sized businesses. In contrast to crowdfunding, it is available to both individuals and legal entities. The minimum investment amount is determined by the platform where the project is placed. The invested funds are always refunded – either as company shares, or as the amount you ‘spent’, plus the interest. The crowdinvesting market in Russia currently exceeds 20 billion rubles; Alpha Stream, StarTrack and Penenza.ru are among its main players.
Among the risks are non-recovery of investments, lower-than-expected profitability and funds freezing. Crowdinvesting is considered a rather risky business, but it can generate fairly good dividends by private investors’ standards. What can lead to losing investment and future profits?
➔Project bankruptcy due to inefficient use of investments.
➔ Fraud by the developers of the project, which may not actually exist.
➔ Fraud by the platform where the project was placed or its bankruptcy. Similar to the previous item, funds may be raised by the platform’s founders for their own needs and projects offered for investment may disappear as soon as the money is transferred.
➔ Investing in project pools. A project pool consists of several projects with each of them getting an equal percentage of the invested funds. Some ideas may turn out to be fakes, and the profit gained will not cover the lost funds.
➔ Deceleration of the company’s development or funds freezing. Under such a scenario, you will be able to collect the invested amount and dividends with a considerable delay.
Pros and cons of crowdinvesting
The main advantages of this investment type are a low entry threshold, a chance to get significant dividends and simple investment diversification (small amounts can be invested in various projects). The main drawbacks: no guarantee of project implementation, a large number of fraudsters in this business niche and the above mentioned risks.
There are significant advantages for a company offering its project to crowd investors. Thus, it can translate its concept into reality without investing any funds of its own, without becoming dependent on large investors.
What is crowdlending
Crowdlending is another type of business projects financing, which differs from the other ones in that individuals act as investors. Only legal entities attract investments. In this way, the individual gets a profit – the invested funds are paid back together with interest for their use. Banks and financial institutions do not participate in crowdlending regulation. In fact, thanks to crowdlending, an individual can buy a participatory share in a company. Any citizen of Russia that is over 18 years old can become an investor on a crowdlending platform. It is another matter that each site sets its own rules of the game. That’s why it is not uncommon for young businessmen’s investments to be rejected.
Do you want to become a crowdlending investor? Before choosing a service, make sure that it works legally, it has been on the market for over three years and is registered with the Central Bank of Russia. You can invest up to 600,000 rubles per year; there is no minimum investment threshold. Usually these funds are ‘given for use’ to companies for the period from 6 months to one year.
There are three investment options on crowdlending services:
➔ You chose the project yourself and you invest exclusively in it.
➔ You invest in a pool of projects selected against a single criterion (financial indicators or risk level and activity area).
➔ The platform allocates funds in equal amounts among all projects, i.e., borrowers.
How much can I earn on an investment in crowdlending?
Creditors pay from 10% to 30% per annum for using investor funds. High profitability comes with no less high risks – the platform is not responsible for the projects offered on it. Another disadvantage of crowdlending is a lack of confidence in the businesses placing their projects on this service. Some companies cannot get a bank loan, so they turn to this fundraising venue.
A bright future is predicted for crowdfunding technologies. Earlier, this investment mode was not recognized by government institutions; however, we are now witnessing some progress in this matter. Thus, a law on ‘retail financing’, i.e. crowdfunding and crowdinvesting was adopted in the summer of 2019. It provides for limits on invested funds (up to 600,000 rubles per year, as mentioned earlier) and the proceeds (up to 1 billion rubles per year). This hasn’t dramatically restricted the Russian crowdfunding segment, but has given investors minimal guarantees. The companies, on the other hand, have received a reliable legal basis for this form of fundraising.