There are three main types of crowdfunding: equity-based, donation-based and debt-based. Generally, if your project achieves its funding goal, all pledged funds are transferred to your bank account. If your project does not meet its funding goal, all pledges are cancelled and no funds are transferred. This article will explore the three main types of crowdfunding, and the benefits and pitfalls of this scheme.

Types of Crowdfunding

Crowdfunding is a scheme where projects, ventures or start up companies seek donations from the public. Investments and donations are usually made through public marketplaces. The marketplace operator will usually coordinate and administer the fundraising. There are three main types of crowdfunding:

1. Equity-based

Equity crowdfunding involves a company raising money by issuing shares (i.e. equity) to a “crowd” of retail or non-professional investors through an online platform. The number of investors that can potentially invest in the company through equity crowdfunding may be hundreds. Usually, private companies cannot have more than 50 shareholders. However, equity crowdfunding laws enable companies to jump this hurdle.

They allow private companies to raise money from more than 50 shareholders provided the company meets certain criteria. If the company meets that criteria, then it can raise up to $5 million within a 12-month period. An investor can invest as little as $0, or as much as $10,000. To engage in equity crowdfunding, the company must:

  • have two directors;
  • ensure that its principal place of business is in Australia;
  • have consolidated gross assets and annual revenue of less than $25 million; and
  • raise funds through an approved intermediary (for example, Equitise, VentureCrowd, OnMarket).

Importantly, if the company chooses to crowdfund using equity, there are several additional requirements that the company must comply. This includes disclosure and reporting obligations, some of which can be onerous on early-stage companies.

2. Donation-based

This involves asking a crowd to donate to a project or business in exchange for non-monetary rewards. The returns can be tangible or intangible (such as the finished product).

3. Debt-based

Also known as peer to peer lending, this form of crowdfunding involves asking a crowd to donate to a project or business in exchange for a possible financial return at a later date. In debt-based funding, you might also be able to access dividend-like returns from the business you invest in. Whether you can or not will depend on the terms of your investment. 

Popular crowdfunding platforms includePozible, Kickstarter and Indiegogo.

Benefits of Crowdfunding

Crowdfunding helps people and businesses gain money by reaching out to a broad, public audience. It can help you source funds more quickly and efficiently compared to traditional channels. This can be beneficial for businesses that are otherwise having difficulty finding funding, whether it be for a creative startup or a non-profit. 

Donators (or crowdfunders) can provide useful feedback on any project, as well as assist with your marketing interests. You can achieve validation of concept much earlier through crowdfunding than through traditional avenues of financing. Notably, crowdfunding platforms allow crowdfunders to personally invest in a project at a range of price points.

Pitfalls of Crowdfunding

Whilst crowdfunding attracts interest from the public, it also exposes your ideas to potential imitators and raises several legal and taxation requirements. This is particularly relevant with equity crowdfunding where you also need to engage an approved intermediary to assist, which can be costly. 

Managing and delivering a crowdfunding campaign requires ongoing communication and maintenance. If you are already busy trying to run your business, you might not have the bandwidth to manage a crowdfunding campaign!

Crowdfunding Websites

Businesses seeking to raise funds through crowdfunding websites need to be cautious of how their raised funds are used. Crowdfunding websites take a cut of the funding that they process through their platforms, as well as charge substantial transaction fees. They also take no responsibility for the trustworthiness of the people seeking funds. In short, crowdfunding websites are not accountable if a project does not succeed.

Key Considerations

Whilst crowdfunding can be a quick source of capital, there are risks for both investors and businesses. Ensure you are aware of the conditions and obligations of funding. Crowdfunding in Australia is still in its infancy. Without substantial regulation in this field, investors should conduct their due diligence before investing. Potential investors should ask how the fund-seeker intends to use your funds if they reach their targets.

To find out more about crowdfunding and whether it is right for your small business, contact one of our capital raising specialists on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions About Crowdfunding

Do I need to be a registered business to crowdfund?

If the project you are seeking to crowdfund for is a hobby, there may not be any GST or income tax implications. However, if you are raising funds to start a business, you likely need to register with an ABN.

Is crowdfunded money a donation?

If you are in business, what you give in return for the money that you receive will help to determine the tax issues. If you treat the money received as a donation to your business, then there could be GST and income tax issues, as it is likely that the money will be revenue. The cost of providing any rewards (say goods or services) should be a tax deduction.

Can I handle an equity crowdfunding process myself?

No. You have to engage an intermediary to assist with the process. If you do not, you will have breached the equity crowdfunding laws and will be penalised, including for breaching the 50 person shareholder limit.

What’s the maximum amount a single investor can invest in a company through equity crowdfunding?

$10,000.

Can someone who has invested in my company through equity crowdfunding trade their shares?

Yes, in certain circumstances. That investor may be able to trade with other investors that have also invested through the same equity crowdfunding round, depending on the terms of the investment.

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