Crowdfunding business models

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While the terminology of the common four buisness model types (donations, reward, lending and equity crowdfunding)  is to some degree widely used in the USA and in Europe, they do not pay tribute to thriving business model innovations that have been created and thus does not take into account the potential disruptive nature of crowdfunding. Going forward more hybrid models, such as partly outlined here, will emerge.

Crowdfunding is transformative in its total of business models, with the biggest potential lying in the combination of
different approaches that will allow funding the whole life-cycle of a project, product, services or other business innovation. This overview is therefore not meant as an inclusive overview but to showcase variety in crowdfunding business models.

Donations
NGO’s have used this model to attract donations for specific projects for over ten years. Unlike with tradiotional fundrasing,
donations are collected and ear-marked for a specific project. Because funders know that their money will be used on a very
specific project, they are more willing to donate higher amounts per person.

These types of donors also tend to be more loyal in the long term when the NGO will keep them updated about the progress of
the project, ensuring recurring donations. The main motivation for funders is social. It is intrinsic motivation, which is usually a
good base for a long term donor relationship.

Rewards
This business model is used by project owners who want to collect donations for a specific project and can give (often small)
non-financial rewards in return. The rewards are of a symbolic value and provided by the investee. They are usually much lower
than the donation amount, to ensure there is enough money left for the project.

Nevertheless, the perception of the value can be much higher, for example special VIP tickets as a reward for a higher donation.
A reward in this context should not be understood as a token of appreciation. In general, the parties do not consider it a legally
binding obligation to provide the goods and do not classify it as a sale.

When the different reward-levels are chosen wisely, it is possible to receive a much higher average donation than with a pure
donation-based approach.

Pre- Sales
It is possible to put a new product or service online and ask funders if they are interested to order and pay in advance. This
replaces traditional market research and validates demand while providing working capital, if successful.

Funders that participate in these crowdfunding campaigns do it because they want this product or service to be made. Another reason is that they will get a discount on the sales price.

Lending
With lending-based crowdfunding, a company will borrow money from a group of people instead of a bank. The role of the platform can be diverse. Some of the platforms will act as a middle-man and will also make the repayments to the lenders,
where other platforms act only as match-makers and the borrower and lenders will be connected when the deal is closed.

  • Social Lending
    Some platforms give the possibility to lend to social projects with no interest being offered, for example where businesses in developing countries can receive micro-financing without any interest being paid to the lending party.
  • Peer-to-Peer Lending
    Although Peer-to-Peer Lending (P2P) is not necessarily based on goodwill, it is an interesting new financing model for loans. It has some characteristics of crowdfunding lending, but the main difference is that the lenders and borrowers usually do not know each other.With P2P lending, the main motivation for the funder is a (higher) financial return. The interest-rates in general are based on the risk-factor. The risk-factor is calculated based on financial data and personal securities. These calculations are currently done by P2P-platforms that show-case the loans or by independent institutes. There are also innovative models in which the risk is borne by provision funds and not the individual lenders.
    This model is used by borrowers who are looking for a loan with a lower interest rate than the one they can get from a bank. It can also be used by borrowers who can offer fewer securities. Existing data shows that default rates for P2P lending on average are very low, below 1%. This subset of crowdfunding is continuously growing and profitable. In P2P lending only the money provided by the funders is being lent out. Therefore there is no money creation within the platforms unlike with traditional banks. As a result, there is no systemic risk attached to P2P lending.
  • Peer-to-Business Lending
    Similar to P2P lending, there are platforms that provide loans to small and medium sized businesses. By today this form of crowdfunding has attracted the attention of government funds as co-investment, for example in the UK.

Equity Crowdfunding
When a company wants to attract an investment from a group of people, instead of funding by a business angel or another
private investor, this is called equity crowdfunding or crowdinvesting.

Some funders are primarily interested in investing in projects that share their own values, that are locally engaging, or that
create jobs in their community. Others have a real knowledge of what the market, project, or company is addressing and desires to bring funds and expertise to the success of the project. This practice is very similar to business angels.

Equity crowdfunding also generally includes equity-like arrangements, offering the same payoff as equity (shares), and where
the “funder” is actually merely a creditor who has a contractual right to receive that payoff.

Hybrid Models
Combined models are also possible. Some platforms experiment with a combined model of loans and pre-sales. A percentage of the funding will be put into a loan (and will be repaid with interest) and the other part of the funding will be used to prefinance the production of the product or service. Also for the entrepreneur there are benefits in hybrid models or in approaches to mix crowdfunding with other investment forms, for example where crowdfunding is used to pre-sell a product, through which market validation and segmentation can be done, to generate revenue and positioning the project for follow-up or parallel investment from business angels.

Variations on these Models
Next to the established models which are mentioned above, there are some variations on these models that can be used.

  • Revenue Sharing
    Funders can also receive a return based on future revenues of the company via revenue sharing arrangements for instance
    or royalty-based financing. Such rare but nonetheless promising alternative payoff structures may be less straightforward to categorise under the notions above, but contractual freedom may allow offering payoff structures that do not resemble equity, equity-like or typical fixed loan payoffs.
  • In Kind (reward)
    Independent of the type of business model chosen, organizations can give a payoff in kind. This means that based on a monetary input, the funder will receive a payoff in kind that has substantial worth. The exact amount is not always clear at the start of the project, and is thus subject to the risk. Normally these are products or services from that organization.
  • In Kind (funding)
    It is also possible to participate in a crowdfunding project as a funder by offering products or services instead of money. In most cases, these products or services otherwise need to be purchased by the project and therefore have a real financial value to the investee. For the funder, the cost of the investment is restricted to opportunity and operating cost.

 

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