Types of crowdfunding - Equity Vs Rewards

There are a variety of ways a business can raise capital in order to meet their ambitions and strategic objectives. Two common routes to funding are equity crowdfunding and rewards-based crowdfunding. We’re often asked about the differences between the two so this article will provide a brief explanation. We’ll start however by mentioning the similarities. 

Similarities

For the first similarity, the clue is in the name. Crowdfunding is simply a catchall for raising funds from a large number of people, most of whom typically contribute a relatively small amount. And that’s exactly the case with both equity and rewards crowdfunding. Contrast this with securing investment from a VC where they may well be the only new investor, with their investment likely to be in the tens, if not hundreds, of thousands. 

Another characteristic shared by equity and rewards crowdfunding is neither are quick nor easy. Both take time and effort. As a huge generalisation I would say the effort versus return ratio is usually better for equity crowdfunding than for rewards. Put another way, you can put in a similar amount of time and effort for say £250k equity investment as you might get for a rewards campaign producing £50k. There are of course always exceptions. 

Rewards-based crowdfunding

So what do we mean by rewards based crowdfunding? Reward-based crowdfunding allows businesses to raise capital from a large group of individuals by offering a tangible reward, often the first run of a physical product or a unique digital product. Example platforms include the likes of Kickstarter, Indiegogo and Crowdfunder.

Let’s talk about a campaign where the reward is a smartwatch. The delivery date for this watch might be well into the future, so the campaign provides a large discount on the anticipated final purchase price to those buyers who order and pay for the watch often many months in advance of receiving the item. The closer an order is to the expected delivery date of the watch, the smaller the discount offered i.e. the purchase price goes up. A variation of this is offering the biggest discount to a set number of buyers on a first come first served basis. So for example the first 50 orders might offer a discounted price of £200, the next 100 may be £250, the next 500 £400 and so on. Those who later on end up just ordering the watch off a website for immediate delivery might pay £1,000 as against the earliest bird purchaser who paid only £200.

So a simple way to think of rewards crowdfunding is that it’s just selling products and banking the sales revenue in advance of actually delivering the product to the purchaser. 

The advantages of this approach is that you can raise funds for your business from these advance sales without having to give away any ownership i.e. equity/shares of the business. If you’re currently the sole 100% shareholder in your business, then a rewards campaign won’t change that. And typically the revenue earned by these advance sales actually pays for the production and delivery of the product itself. 

One of the downsides is that the amount of advance revenue you can bring into the business is ultimately determined by the sale price of the product and the amount of product you can build, distribute and deliver. And exceptions aside, this can only work for relatively low priced products say in the hundreds of pounds. 

Equity Crowdfunding

Equity crowdfunding works by selling shares in your business. So the person who invests into your crowdfunding campaign on say Crowdcube or Seedrs actually then holds a stake in your business, they become a part owner. Prior to raising any equity investment, the only shareholders in your business might be just you and say your co-founder. You may own 50% each or it’s possible you could have agreed a different share split at the outset e.g. you own 60% and your co-founder 40%. 

So when you raise money for your business by selling some shares, that will mean your % ownership of the business will reduce. This is referred to as dilution. For example you might put up a maximum of 20% of your business for sale via crowdfunding. Once your campaign successfully closes, if you and your co-founder were initially both 50% shareholders, then each of your shareholdings would reduce to 40% with the remainder of your shares owned by the folks who supported your campaign.

It’s fair to say that equity crowdfunding is overall more complex than rewards crowdfunding and needs serious and long-term-impact decisions to be made. The most important decisions are around how much of the business are you prepared to put up for sale i.e. what percentage of equity will you offer, and how much you will try to sell each share for. Setting the share sale price means setting an overall valuation for your business. Valuation is a topic on its own and discussed here: 4 Common Valuation Models - An introduction.

So just to be clear, rewards-based crowdfunding isn’t our thing. But if you think you might be ready to raise business investment via equity crowdfunding, do book a call below. 

Author: Richard Mojel - Commercial Director ISQ