Need funds for your business? Here's what you should know about crowdfunding

Dubai: Crowdfunding, like the word suggests, is when a ‘crowd’ funds a project or business, rather than one or two major investors.

In other words, crowdfunding is when businesses, organisations or individuals fund a project or venture with small donations from many people. By receiving the necessary boost to cash flow, these ventures can get off the ground or launch new projects.

Most of these campaigns happen via internet platforms, have set time frames for when money can be raised and disclose specific monetary goals.

To run a successful crowdfunding campaign, you need to essentially capture the attention of a large number of funders or backers and convince them that your project is worthy of their investment.

This guide is for start-ups and small business owners who are interested in learning how crowdfunding can be used to obtain funding.

The beginnings of crowdfunding

Crowdfunding has been around for many years, arguably for centuries. In the modern era, however, it is ostensibly linked with information technology and online platforms starting in the late 90s and early 2000s in connection with arts and music communities.

Today, however, crowdfunding is most closely associated with the online offering of private company equity or debt investments and as such is subject to securities and financial regulation.

In most jurisdictions, restrictions apply to who can fund a new business and how much they are allowed to contribute.

Similar to the restrictions on hedge fund investing, these regulations are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. Because so many new businesses fail, their investors face a high risk of losing their principal.

What are the different types of crowdfunding?

There are four kinds of crowdfunding campaigns you can use for your business: rewards, donation, debt and equity.

While there are four types of crowdfunding, each receives money from interested donors. Here's a breakdown of each one:

Donation: Donation-based crowdfunding is when people give a campaign, company or person money for nothing in return. Let's say you create a crowdfunding campaign to purchase new equipment for your company. The individuals who give you money do it out of support for the growth of your business and nothing else.

Debt: Debt-based donations are peer-to-peer (P2P) lending, which is a form of crowdfunding. In debt-based donations, the money pledged by backers is a loan and must be repaid with interest by a certain deadline.

Rewards: This is when donors receive something in return for their donations. The rewards vary by the size of the donation, which incentivises higher contributions. Based on how much money participants give to a campaign, they may receive a product or service – often at a discounted rate.

Equity: While some crowdfunding campaigns don't allow backers to own a portion of the company they're supporting, equity-based crowdfunding allows small businesses and start-ups to give away a portion of their business in exchange for funding. These donations are a type of investment, where participants receive shares in the business based on how much money they contribute.

Crowdfunding in the UAE

Examples of crowdfunding platforms in the UAE are DubaiNEXT, Beehive, Eureeca. DubaiNEXT is the first official governmental online crowdfunding platform for start-ups.

In the UAE, fundraising activities for charities and social causes are regulated and done through state-based registered channels. However, fundraising for loans and investments, or debt-based funding is a new concept and yet to be regulated and introduced at a wider level.

Why crowdfund?

Data provided by Abu Dhabi-based Khalifa Fund shows that approximately 50-70 per cent of the Small and Medium Enterprises (SMEs) applications for funding are rejected by conventional banks.

Loans to SMEs account for just 4 per cent of the outstanding bank credit in the UAE, below the Middle East and North Africa (MENA) region (MENA) average of 9.3 per cent.

“Conventional lenders are sometimes unwilling or unable to support SMEs given their limited assets or lack of a proven record of company operations,” the official UAE government portal (u.ae) adds. “This makes it difficult for SMEs to do business and finance provisions can be expensive or inflexible.”

“Yet, SMEs contribute nearly 60 per cent of the UAE’s GDP and this is estimated to grow to 70 per cent by 2021. Hence, crowdfunding is needed in the UAE to support SMEs,” the UAE government portal further noted.

Examples of popular crowdfunding sites widely used globally

Kickstarter: US-based Kickstarter is a rewards-based donation platform that has been helping companies raise money since 2009. It has been used to raise about $6 billion (Dh22.04 billion) for more than 204,763 projects.

GoFundMe: GoFundMe is a donation-based crowdfunding company, and although it's famously used for more charitable initiatives, businesses can take advantage of the platform as well. Statistically, 1 in 10 campaigns is fully funded on the site.

Indiegogo: Indiegogo is a reward-based platform that offers two kinds of funding. Fixed funding allows to set a goal for a certain amount of money, and if the target isn’t reached, all funds are returned to donors. When it comes to flexible funding, all the funds can be kept whether the goal is hit or not.

Why choose fixed funding?

The biggest reason to choose fixed funding is if your project absolutely cannot be completed without a minimum amount of capital.

If you’re trying to bring a product to market, you’ll probably want to choose fixed funding unless you’ve raised capital by other means and are simply supplementing funds with a crowdfunding campaign.

The risk of not meeting your crowdfunding goal is also a bit lower if you’re using fixed funding. Campaigns that use fixed funding but don’t meet their goals won’t have to pay any fees on some platforms as the funds are returned to your backers.

Flexible funding campaigns that fail to reach their goals, on the other hand, will have to pay a flat 5 per cent platform fee on some platforms as well as having to incur payment fees from credit cards. This incentivises companies to set reasonable goals.

Fixed funding also works to minimise risk for your financial backers. Since backers won’t be charged unless your campaign reaches it goal, there’s less risk of your company not delivering on promises.

This is as fixed funding campaigns usually know the exact minimum amount of capital needed to bring a project to life.

Why choose flexible funding?

Flexible funding lends itself to personal fundraising, causes, and charities where goals don’t need to be met. This allows charities to set ambitious goals with little risk if they’re not met, as they’ll be able to keep whatever money they do raise.

However, if you’re funding a product with flexible funding, you need to be able to deliver on your promises and campaign perks even if your campaign doesn’t reach its funding goal.

Like mentioned earlier, companies who are raising capital from a variety of sources may still be able to complete their projects without reaching their crowdfunding funding goal.

Advantages and disadvantages of crowdfunding

The most obvious advantage of crowdfunding for a start-up company or individual is its ability to provide access to a larger and more diverse group of investors or supporters.

Crowdfunding platforms also provide an added advantage wherein businesses and individuals can grow their audience and receive the funding they need.

Furthermore, many crowdfunding projects are rewards-based; investors may get to participate in the launch of a new product or receive a gift for their investment. For instance, the maker of a new soap made out of bacon fat may send a free bar to each of its investors.

Video games are a popular crowdfunding investment for gamers, who often receive advance copies of the game as a reward.

Equity-based crowdfunding is growing in popularity because it allows start-up companies to raise money without giving up control to venture capital investors. In some cases, it also offers investors the opportunity to earn an equity position in the venture.

Potential disadvantages of crowdfunding include the fees associated with the crowdfunding site and at least on some platforms, if you don't reach your funding goal, any finance that has been pledged will be returned to your investors and you will receive nothing.

So check with the crowdfunding platform beforehand if they stick to a fixed funding process or a flexible funding plan.

Four steps to start your own crowdfunding campaign

Select your platform: Start by choosing between a rewards or equity-based platform. Find out how long the different platforms allow campaigns to run. That can be important. What’s the limit on how much you can raise? And find out who will see it. Certain platforms might attract different types of backers.

Get accepted by the platform: Fill in the online forms and provide any documentation they need. The platforms need to check you’re legitimate. An offer document or prospectus may be required if you’re looking to use an equity crowd-funder. This sets out the details of the investment, any prescribed risk warnings, and cooling-off periods for investors.

Make your pitch: Once accepted by the platform, you have a place to make your pitch. Describe your project or idea, why you want funds, and how much you’re hoping to raise. If it’s a rewards-based platform, list what backers will get. For an equity-based platform you’ll need to state what the equity stake is and the share price – if it can be determined.

The pitch phase can require a lot of work. It’s a full-on marketing campaign to promote your project or business and make it attractive to investors. And it may involve frequent updates to keep the interest going. Your business needs to use its customers and fans on social media channels to get the word out.

With an equity crowdfunding campaign you’ll need to share your business and financial information with complete strangers. That includes up-to-date company information, financial statements and forecasts, a credible business plan, and – if you’re an existing business – a realistic valuation.

Campaign end: With some social crowdfunding platforms you get all the donations raised during the campaign. With others, you have to set a target and only get the cash if you reach it.

With equity crowdfunding, you’re given a time frame to attract investors. If you’re successful, the platform arranges the payment of the funds to you and issues share to the investors. If you don’t attract investors, you may be able to extend the deadline.

These platforms make their money through fees – for instance a percentage of the amount raised plus transaction fees. Some also take equity, while some won’t charge a fee unless you’re successful. They’re handle the administration aspect, and in the case of equity platforms, they’re handling the legal compliance that can be complex to do on your own.