This article is written by Sugandha Nagariya, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
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Do you want to invest in innovative start-ups? But can’t wait until their IPO (initial public offering), it is now possible because of crowdfunding platforms like Seed invest, Republic, Wefunder, Start engine, etc.
http://www.ketto.org/ and http://fundraisers.giveindia.org/ sites are the current examples of online crowdfunding platforms in India where any individual/organ across the country can raise funds for causes ranging from medical healthcare to disaster relief. Thus crowdfunding platforms are the emerging source of investment where people can raise funds for their start-ups or projects easily from a large number of people.
What is Crowdfunding?
Crowdfunding is a method of raising funds. As the name suggests crowdfunding means funds raised by a crowd of investors. Crowdfunding is when individuals or start-ups use an online platform to gain funding for a project globally.
SEBI, in 2014, presented a consultation paper on “Crowdfunding” in which crowdfunding is defined as:
“Crowdfunding is a solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause.”
Crowdfunding is a means of obtaining funds from the general public for specific objectives such as a creative endeavor such as music, film, or book publication, to fund a new company endeavor, or for charitable causes such as community-based initiatives, social concerns, or medical emergency donations.
There are four types of crowdfunding, which are as follows
- Debt-Based crowdfunding – In this, the contributors receive interest payments in exchange for their contributions, examples include FundedHere, Crowd, MoolahSense, etc.
- Equity-based crowdfunding– In this crowdfunding, contributors receive shares in exchange for their contributions; examples include AngelList, Fundnel, Seedrs, Capbridge, etc.
- Reward-based crowdfunding– This crowdfunding is where contributors are promised rewards in exchange for their support, like get priority access to the product once it goes live, examples are Kickstarter, Indiegogo, Ulule, etc.
- Donation-based crowdfunding– This crowdfunding is where donations are charitable and usually tax-deductible, examples are Ketto.org, Indiegogo. Patreon, YouCaring, FriendFund, etc.
Crowdfunding websites have to invest heavily in their platform upfront and slowly build upscale, so before investing in a crowdfunding platform it is important to consider its stage of growth.
What are the advantages of Crowdfunding as compare to other sources of raising capital?
Crowdfunding brings a new perspective to the process of investing and raising funds. It has many advantages for both businesses and investors as compared to other sources of raising capital.
Before citing the advantages of crowdfunding, we should go through a selective list of other sources, which is as follows:
- Angel investor;
- IPO (Initial public offering);
- Venture Capital;
The following are the advantages of crowdfunding:
- Silent investors- In crowdfunding, there is an Equity-free funding option. While companies can utilise equity to entice investors through a crowdfunding platform, it isn’t always necessary to relinquish control of the firm to raise funds. You can utilise a rewards-based technique to generate funds on some platforms.
- It may be easier to attract investors- Getting other investors on board can be a time-consuming process because it usually requires many pitches of your startup’s ideas. Crowdfunding platforms, on the other hand, simplify the process by allowing entrepreneurs to put their pitch in one place for a wide range of investors to see.
- Crowdfunding helps in getting Validation- Validation is very crucial for start-ups. Validation simply means that you have verified that your start-up is solving the problem of other people and they are willing to pay for it. Thus validation will let you know that consumer wants your start-up to exist in the world and it is something that has demand.
- Crowdfunding can help you gain more visibility– Marketing can eat up a lot of a startup’s resources, but raising funds through a crowdfunding platform is a low-cost way to get the word out. When a crowdfunding campaign gets financed rapidly, it indicates that the startup is one to keep an eye on. This can help to raise the brand’s awareness and attract more investors for future funding rounds.
- No Middleman– Compared to other sources of funding, crowdfunding platforms provide the removal of the middleman. No agents, no brokers and thus you can save that fee which adds up across several deals, thus saving you a lot of money. This is mostly helpful in real estate investments.
What are the effects on Venture Capitalist’s investment via crowdfunding?
Venture capitalists (VCs) are investment firms or groups of investors who seek to financially support budding startups and small enterprises. They invest in exchange for stock and can give many rounds of funding as a business expands.
VC firms are unlikely to be interested in the transaction flow that crowdfunding can give. To begin with, venture capital firms employ teams of investment professionals whose main purpose is to drive transaction flow. If these companies rely on crowdfunding platforms for deal flow, charging a 2% management fee and 20% carried interest to their limited partners is tough to justify. Secondly, there’s been a lot of talk about how crowdfunded startups won’t be able to raise VC money in later rounds because VCs don’t want to deal with the complexities of a fragmented investor base.
The greatest way for venture capitalists to interact with crowdfunding sites is to invest in the finest crowdfunding platforms. The finest locations will be able to attract venture money. However, in general, fewer than ten equity crowdfunding platforms will garner VC capital from high-quality companies, as network effects will ensure that the best platforms profit from the finest deal flow and investors.
However, VC or founder should embrace crowdfunding, when it suits their company.
Crowdfunding has a more disrupted effect on VC’s, because of the following reasons:
- In crowdfunding other investors’ competition diminishes the value of VCs, who may abandon the deal outright. Entrepreneurs who miss out on crucial VC operational experience may suffer as a result (operational support, access to supplier networks, etc.)
- Currently, venture capitalists and private equity investors in India carry the risk of supporting start-ups. However, under the crowdfunding technique of raising funds, start-ups raise capital from a large number of investors in tiny quantities. As a result, the risk that was formerly held by educated investors is now passed to these small retail investors, who may not be able to bear it. This may perplex these retail investors because small business and start-up investments carry a high level of risk and have limited liquidity.
- Scammers may set up a website posing as genuine supporters of a cause or viewpoint. As a result, there is a risk of misuse, cyber-security, and identity theft. Thus, venture capitalists are at risk of losing their investment.
- There is a lack of liquidity because there is no secondary market where investors can resell their funds and exit. Money laundering is also a possibility, and because the money is transacted through the internet, there may be cross-border ramifications as a result of the jurisdictional disparities.
What are the different platforms through which Venture capitalists can invest in crowdfunding?
- Catapooolt was founded by Satish Kataria in July 2013. In this platform, the project submission fee is 23 USD plus 10-15% commission of the total funding raised. This crowdfunding platform has helped 40 projects to raise funds amounting to almost 150,000 USD from over 2000 contributors.
- DreamWallets founded by Nikhil Agrawal and Manish Harodia in April 2015. If one raises 100% of the funding goal or more only then he/she gets to keep the money raised or else it goes back to the contributors by deducting 3-6% (the actual) as payment gateway charges. They do not charge the campaign owner anything. Entrepreneurs have raised about 1 crore in cash and kind.
- Faircent was founded by Rajat Gandhi, Vinay Matthews, Nitin Gupta in 2013. On this platform One-time listing fee of around USD 23 + an administration fee is paid which depends on the size of the loan and interest amount With 6,000 potential lenders and 26,000 want-to-be borrowers on its platform, Faircent has disbursed total loans of almost USD 973,000 in the last 24 months.
- FuelADream was founded by RanganathThota in 2016. They charge 9% (2% gateway +7% contract charges) of the total amount collected in any of the campaigns. On the 9%, they charge an additional 14.5% service tax. All and all, the overall commission stands at Notable campaigns so far include a battery-powered e-bike and a canal to irrigate a village‟s arid farmland.
Crowdfunding is a new tool for businesses to employ that has recently emerged on the scene. Because angle investors and other sources are no longer the primary conduits between firms and investors, more entrepreneurs have access to cash and investors have more chances to participate in early-stage startups. More companies will receive money, and more investors will participate, thanks to crowdfunding’s lower costs and better liquidity.
Though after citing various disadvantages of crowdfunding on VCs it is advisable that what works best for you is determined by the nature of your firm and its objectives. It’s crucial to remember, too, that you should look into all of your financing alternatives.
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