An accelerated guide to crowd-funding for starting-up and personal finance.

The concept was used as early as 17th century to finance printing of books and funding of musical concerts in Europe. Even Mozart is said to have used it to bankroll his concerts.

What is crowd funding? To make sure we are on the same page.

Crowd funding is a web-based financial service, that brings together capital seekers and capital lenders in an online platform for raising funds in return for a wide range of motivations. The premise of financing stays the same except that capital seekers raise funding not through traditional sources like banks or angel investors but through a large number of retail investors through online platforms.

Crowd funding are of four types:

1. Equity/ ownership splits:

It refers to fund raising by early stage businesses in return for ownership interests to investors online. Equity crowd funding is illegal in India though, due to limited savings and liquidity issues of retail investors.

2. Debt/ Borrow:

It is a form of peer-to-peer funding where individual/ institutional lenders provide loans to people or businesses on an unsecured or secured basis in return for interest and principal. Interest rates and tenure is set by the platform and only NBFCs are licensed to undertake such transactions. Faircent in India is one such example.

3. Reward/Incentive based

In this type of crowd funding investors contribute to a business in the present with an interest of receiving finished products, premium services or membership reward schemes in the future.

4. Donations

This is a pure-play donation-based crowd funding where investors contribute in businesses, they are passionate about, or for any social or artistic cause. Ketto is a prominent platform in India which helps raise money for medical bills for critical illnesses.

2 key points differentiate crowd funding from other sources of financing:

1. Funding from a large number of people:

The funding is raised from a large group of people (hence ‘crowd’ funding) who may be located at different regions of the country. As these funders (retail investors) often do not have a large corpus of funds available or the risk appetite to take concentrated bets, the funds of many such capital lenders are combined to fund a particular business or cause.

2. Funding through online platforms:

Leveraging an online platform, helps seekers and lenders of capital from different regions to connect, and facilitate transparency and smooth flow of information. Additionally, using technology, personal, professional and financial data of borrowers are analyzed quickly, at fraction of the cost with automated suggestion of viable rates, loan tenures and amount depending upon the borrower’s creditworthiness.

Forms of Crowd funding

There are various forms of crowd funding which derive from the four categories namely debt-based, equity-based funding, reward-based and donation-based crowd funding. We discuss only debt-based and equity-based forms given their primary share of the overall global crowd funding market.

Debt-based: Borrowing money from individual/institutional investors

• P2P lending: Individuals and/or institutional investors provide loans to people for consumption purposes such as wedding loans, student loans, car loans, travel loans etc.
• P2P Business lending: A type of debt-based crowd funding where individuals and/or institutional investors provide loans to often small-and medium sized businesses for working capital or capex requirements.
• P2P Real Estate lending: Individuals and/or institutional investors provide loans to consumer or businesses against secured property.
• Invoice Trading: These include loans given to businesses for financing receivables and invoicing. The purchase invoice or receivables note is bought by the investor at a discount to the original amount.

Other forms of debt-based crowd funding such as mini bonds, balance sheet lending, P2P student lending and blockchain based loans also exist.

Equity-based crowd funding:

• Startup Funding: It is where individuals and/or institutional investors invest in seed-stage startups, for a percentage ownership interests or shares in the business. The investors are entitled to a share of the profits if the venture succeeds and will lose all or part of the investment if it fails.
• Real Estate funding: A large pool of funders each contribute a small amount of money to buy a real estate property. Facilitated via. online platforms, this type of a crowd funding is a popular method of financing among property developers.

State of Crowd funding: Worldwide

Let us begin with a global context, before we discuss India. Crowdfunding has international roots. The concept was used as early as 17th century to finance printing of books and funding musical concerts in Europe. However, in the modern day crowd funding has become an incredible source of funding for many businesses around the world. Countries such as US, Canada, New Zealand, UK, Sweden, China and Kenya are some of the major countries where crowd funding is mainstream. It can be argued that countries where a large proportion of people spend and invest online, owing to developed digital payments structures are fast adopters of this growing form of financing.

Debt financing is the most popular form of financing in the world. According to reports by the Cambridge Center for Alternative Finance, debt-based crowd funding models account for the highest share of overall crowd funding markets in most parts of the world. The chart below show overall share of crowd funding in different regions of the world.

Equity-based financing are relatively popular in Europe and Asia Pacific (less China) markets, accounting for 14% and 13% of the overall crowd funding market. Equity-based crowd funding was found to be the lowest in China accounting for 0.3% of the overall crowd funding market.

Still nascent stages in India

Due to various risks associated with unregulated investments in Equity crowd funding, SEBI has classified it illegal. Risks such as less to no recourse on the issuer of the security, asymmetric information, limited savings and liquidity of the issuer has hindered Equity-based crowd funding’s take-off in India. Although, equity-based crowd funding is illegal, donation and reward-based crowd funding are completely legal.

Transaction volume in Indian cloud funding as of 2017 was US$ 6 million which is expected to grow to US$ 16 million by 2021. The average funding per campaign dropped from US$ 171.6 in 2017 to US$ 145 in 2019. This is compared to the global average of US$ 780 of average funding per campaign (as per Statista).

Originally published at https://www.linkedin.com.