There are four types of crowdfunding. Donation-based crowdfunding refers to occasions where individuals donate money to causes and projects, usually to support a significant or life-changing cause such as health or charitable related issues. Lending-based crowdfunding (also known as debt crowdfunding – but we prefer “lending”) is the process by which individuals lend money to project creators, who then repay the investors back their money over a period of time – and rewards-based and equity crowdfunding, which we will discuss in this article.

Equity crowdfunding

Equity crowdfunding describes the process by which a number of individuals invest in a business in return for shares in their company. Equity crowdfunding sites include Crowdcube, Fundable, Seedrs and Fig. Since April 2012 this type of crowdfunding has increased after the authorisation of the Jumpstart Our Business Start-ups (JOBS) Act. Equity crowdfunding tends to be targeted more towards technological, industrial and professional businesses and services and their campaigns generally last for several months and work well with start-ups requesting $100,000 or more in funding.

Rewards-based crowdfunding

Rewards-based crowdfunding, the more popular of the two, is the course where the crowd contributes towards a campaign in exchange for a reward. Usually the reward is the product that the project creator is launching through the campaign. The benefits with this type of crowdfunding are that you won’t launch your project in debt, like in lending-based crowdfunding, or give out stakes of your venture to investors, like in equity crowdfunding. The most recognised rewards-based sites are Kickstarter and Indiegogo which we have talked about in a previous post.

So what’s the difference?

Both equity crowdfunding and rewards-based crowdfunding have different objectives and appeal to different people. While companies such as Kickstarter and Indiegogo target the crowd, equity sites such as Crowdfunder focus on investors. The key differences here are campaigns or ideas as opposed to businesses. Kickstarter and Indiegogo, for instance, take on campaigns that are generally perceived as good products (most of the time). Their focus is on projecting a good idea and observing whether or not there is a demand for it – if so, the crowd can pre-purchase it. If it is successful enough after the campaign it may be turned into a business. However, by “successful” we don’t mean campaigns that have been successfully funded – because having a fruitful campaign does not ensure success. Equity crowdfunding exceeds just having a “good idea” and focuses more on the business. They also require money to fund, but the aim of equity crowdfunding campaigns are not product-based. Usually the campaigns focus on the longevity of the business, how it will thrive and survive, the profit and how it will continue to succeed over the years.

A product may have flaws and may not necessarily be the greatest but it is the promise of it turning into a prosperous business that secures funding from investors. With rewards-based crowdfunding, individuals can invest in what seems like a good product (it may even exceed its funding goal) – yet it could still flop due to bad management.

With rewards-based crowdfunding sites, anyone can start a campaign – hence the high number of joke campaigns out there. However, crowdfunding for equity eliminates the ridiculous campaigns, as this is much more about serious business. Equity crowdfunding sites seek to source out entrepreneurial ventures and with the donations that most expect, starting up a campaign on a donation/rewards-based site may not secure them the right amount of funding.

Looking at the crowdfunding campaigns on Indiegogo and Kickstarter that received millions of dollars, the funds raised way surpassed their original goals. For instance, the Pebble Smartwatch had a target goal of $500,000 goal but attained over $20 million, and the Coolest Cooler targeted $50,000 but raised over $13 million.

However, equity crowdfunding sites are for businesses that generally need hefty sums of money. If they were to publicise their campaigns on a site such as Kickstarter there is a chance they may not get funded.

Furthermore, for businesses like these the advantage of setting up a crowdfunding campaign on an equity-based site is that they have like-minded individuals that are willing to invest in their business. The key words here are invest and business for equity crowdfunding, whereas rewards-based crowdfunding sites are more so concerned with funding and the product.

The audience on equity crowdfunding sites are typically investors, so often have more money to contribute. If you launched a rewards-based campaign on Indiegogo, for example, with a £50,000 goal it would be unlikely for 50 people to pledge £1,000 each to your campaign. Yet this is common with equity crowdfunding.

Feedback is everything

As it’s not all about the money, there is another important distinction to make. The way crowdfunding sites are set up enables individuals to comment and give feedback on campaigns that they have contributed to. With equity crowdfunding you will receive expert advice from individuals in your field or industry that your product is involved in – which can be invaluable when starting out.

We can see the clear difference between equity and rewards-based crowdfunding as investing as opposed to funding; and crowdfunding a business compared to a product. Equity crowdfunding appeals to start-up companies – individuals investing in the company receive a share, unlike everyday individuals starting a campaign for a product and then giving rewards to funders if the campaign becomes successful. However, with the approval of Title III of the JOBS Act enabling everyday individuals to invest in start-ups… could this diminish the difference between rewards/donation based crowdfunding and equity crowdfunding over the years? We can only wait and see.