Crowdfunding is spreading as an alternative finance option for businesses, and to keep investors and entrepreneurs up to speed with the latest developments in the market, the European Commission has published a guide to frequently asked questions.
Table of contents
For anyone considering taking part in a crowdfunding project, here are the top FAQ answers:
What is crowdfunding?
Crowdfunding is an open call for cash online for help to fund a specific project by matching a number of investors willing to put up small amounts of cash with an entrepreneur
Is the cash raised a donation or investment?
Crowdfunding has more than one financial model, including:
- Donations – Where nothing is offered in return
- Rewards – Merchandise or discounts are offered to investors
- Pre-sales – Collecting funds to develop a product or service which is then given to the investor in return for the advance funding
- Crowd lending – Money is borrowed and repaid without security
- Crowd investing – Investors put up cash for the project in return for a profit share, equity stake another business arrangement
Some projects are a mix of some or all of the different options, depending on the amount of money staked by the investor
How popular is crowdfunding?
Crowdfunding has grown in popularity since the credit crisis and the drying up of funds from banks to finance small businesses.
The European Commission estimates around 500,000 projects worth £610 million went ahead in 2012. The figure is expected to jump to near 1 million projects worth around £829 million in 2013.
Nevertheless, the figure is low compared to bank lending of £4.3 trillion across Europe in the same period.
Does crowdfunding offer any benefits?
The European Commission considers a lot of creative, innovative and cultural projects win crowdfunding that would otherwise remain on the drawing-board as social entrepreneurs have difficulties raising money through formal banking channels.
Small businesses that would have problems financing start-ups also benefit from crowdfunding. The commission reckons 2,800 crowdfunded projects spawned 7,500 jobs in Spain in 2012.
What about the risks of crowdfunding?
Investors need to have their wits about them to watch out for fraudsters, says the European Commission.
Here’s a list of potential risks highlighted by the commission:
- Misleading advertising
- Online platforms failing to return contributions for discontinued projects
- Entrepreneurs diverting funds away from projects into their own pockets
- Legal uncertainty over crowdfunding investment agreements due to complicated cross-border laws and tax rules
- Lack of a clear investment exit strategy
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