knowledge | 22 October 2020 |
Head in the Crowds: Is Crowdfunding the Right Choice for your Start-Up?
With your innovative, new business idea firmly decided, it’s now up to the business to find a way to finance its offering, turning a business plan into a reality. In this article, we consider crowdfunding as a financing option – its pros and cons, and considerations you should be aware of before choosing crowdfunding for your business.
Traditionally, businesses would approach an established lender (such as a bank) to provide a loan for the development of the enterprise. Increasingly, creative start-ups are being no-less creative in financing their work, turning to crowdfunding platforms to realise their financial ambitions. In recent times, we have seen a sharp uptake in the number of early-stage clients considering Crowdfunding as an option, particularly since the COVID-19 pandemic struck our shores.
What is crowdfunding?
Crowdfunding is a method of financing a venture, project or business idea. As the saying goes, “many hands make light work” – and so instead of receiving a large sum as a loan from a financial institution, the business receives a larger number of small sums from a large group of individuals. Usually, these individuals (the “crowd”) are brought together online, using a crowdfunding platform or through social media.
Is there just one type of crowdfunding?
In short; no – crowdfunding is an umbrella term, and there are a number of different ways for the crowd to realise a return on their investment. These include:
- Equity Crowdfunding, where the crowd receives a stake in the new business in return for the amounts raised by the crowd;
- Peer-to-Peer (P2P) Lending, where the company receives money from the crowd, with the intention of it being repaid with interest;
- Rewards-based Funding, where the crowd makes its contributions on the understanding that it will receive a non-financial return in the future, such as a product being made by the company;
- Donation Funding provides cash to the business from the crowd, with no expectation of reward or return;
- Revenue-share Funding, where the crowd gives cash to the business now with the intention of participating in future profits or revenues;
These are just some of the ways that crowdfunding can work for business, and start-ups can be as inventive with their funding as they like, with some choosing to blend these (and other) models to achieve their financial goals.
Is crowdfunding regulated?
Crowdfunding is not currently a regulated activity in Ireland, and no legislation currently addresses crowdfunding directly here. The activities of crowdfunding platforms may, on occasion, bring them within the remit of other legislative schemes – for example, if a crowdfunding platform facilitates lending to “consumers”, it may be considered to be a credit intermediary under the Consumer Credit Act, 1995, and would require authorisation to carry out this type of activity.
The European Parliament recently agreed a new Regulation on European Crowdfunding Service Providers for Business (the “Regulation”), which will enable better cross-border use and integration of crowdfunding platforms across the EU. The Regulation will apply to P2P crowdfunders facilitating “business funding”, as well as those investment crowdfunders insofar as their activities relate to transferrable securities, subject to certain monetary thresholds. European Crowdfunding Service Providers (“ESCP”) will have to seek authorisation from the National Competent Authority in which they operate, but EU rules on passporting will facilitate their operation in an EU jurisdiction outside that which has granted the authorisation.
The Regulation is set to apply in all Member States with effect from 10 November 2021.
Is crowdfunding right for your business?
Like all methods of financing, crowdfunding has its pros and cons, and whether it’s right for you will need to be considered in each case. Crowdfunding’s chief advantage is its flexibility, as well as the accessibility it offers – businesses can instantly gain access and market to a crowd of motivated investors who want to see their idea succeed, and having a large crowd can build a community-feel to the business with invested ambassadors that drive it forward. Crowdfunding also allows the business to share its ideas with the public, providing proof of concept and validation of the business model that is useful evidence for later funding rounds. In the midst of the global COVID-19 pandemic, soliciting smaller investments may be more realistic than achieving larger financing from a single institution. It is also worth noting that Crowdfunding generally does not require the start-up to cede any control over the running of its business (either through board appointment rights or veto/negative controls) in the way it might have to with a venture capital investor.
Start-ups need to be aware of the drawbacks of crowdfunding too. Arguably the biggest of these is the disclosure required by the new, innovative enterprise, as participating in crowdfunding inevitably means sharing your business’s idea with the world at large online. This can also mean intense scrutiny from experienced investors, who will interrogate your proposals and the financials underpinning it. Crowdfunding is currently unregulated in Ireland, meaning inexperienced “armchair” investors may sustain losses if the enterprise fails, resulting in reputational damage to the business and its owners and managers. Many crowdfunding platforms employ an “all or nothing” strategy; that is, either the business reaches its target for investment, or no investment is made, and any money taken by the platform to date is returned to the crowd. Some crowdfunding platforms will also charge commissions in order to host the crowdfunding campaign. Finally, depending on the structure, it may be that each individual member of the crowd becomes a shareholder in the venture, with divergent views potentially creating administrative difficulties down the line.
How can we help?
McCann FitzGerald is a premier Irish law firm. With over 650 staff located in our principal office in Dublin and our international offices in London, New York and Brussels, our specialists are ready to help your business thrive. Our Corporate practice combines with our Company Secretarial and Compliance Services group to offer your start-up enterprise the market-leading advice that you need to grow, from corporate advice on fundraising and governance, to day-to-day advice on compliance matters – leaving you free to focus on developing your business. Please contact any member of the McCann FitzGerald Start Strong team for assistance.
Also contributed by Graham Murtagh.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.