The use of crowdsourcing as a way to raise financial backing for creative projects and new businesses is becoming more common. This asset class might also be used by investors who are looking to diversify their portfolios. The fact that it has gained popularity over the course of the last several years does not mean that it is risk-free. This article takes a look at some of the possible drawbacks of crowdfunding and provides some recommendations for avoiding or minimizing those drawbacks. So, let us get started right away!
What Is Crowdfunding, and What Is a Crowdfunding Platform?
Crowdfunding campaigns are often used to generate money to support a variety of endeavours, including companies and other projects. The collective noun for websites that facilitate donations to charity causes is “crowdfunding platforms.” In “peer-to-peer lending,” also known as crowdfunding, borrowers and lenders communicate directly with one another via the use of the internet.
Understanding the 4 Types of Crowdfunding
Crowdfunding may be beneficial for all parties involved in many situations. One kind of crowdsourcing is known as private equity crowdfunding, although there are many other types of crowdfunding as well. There are many subtypes of crowdsourcing, including reward-based crowdfunding, donation-based crowdfunding, and debt-based crowdfunding. Let us have a look at all four instances that have been provided below.
1. Equity Crowdfunding
Equity crowdfunding is a particular subset of crowdsourcing in which investors obtain company shares in exchange for their financial contributions. The phrase “equity crowdfunding” refers to this subset of crowdsourcing. Those that invest money into a company are recognized for their contribution by being given ownership interests in the company. Crowdfunding equity investments is a terrific choice for anyone looking to back a startup business or a small company.
Investing in equity via crowdsourcing carries a significant level of risk. In the event that the firm declares bankruptcy, you run the risk of losing all of your money. Before you put money into equity crowdfunding, you should make sure you fully comprehend the potential downsides.
2. Rewards-based Crowdfunding
One subcategory of crowdsourcing is known as “rewards crowdfunding,” and an example of this would be providing financial support to a project in exchange for some benefit. A reward might be anything, from a simple statement of gratitude to a promotional code for a future purchase; the possibilities are endless. This kind of crowdsourcing is often used by creative types like musicians and artists.
3. Donation-based Crowdfunding
A kind of crowdfunding in which donors do not get any physical products or services in return for their financial support. Crowdfunding initiatives, which depend on monetary contributions, are often used by charitable organizations and other non-profit organizations.
4. Debt Crowdfunding
“Debt crowdfunding” is a kind of crowdsourcing in which investors provide loans to borrowers in exchange for interest on the loans they make. Through the use of debt crowdsourcing, borrowers now have access to an alternative to the conventional bank financing option.
Key Risks of Crowdfunding
Investors who are not accredited run the danger of experiencing higher loss, as well as liquidity risk and financial loss, when they participate in crowdfunding. The following is a list of the top 10 most common worries about crowdfunding:
1. Liquidity risk
It is possible that you will be unable to quickly sell your investment at a profit if you want to do so. This is the risk that you take. A significant number of the investments that may be made via crowdfunding platforms cannot be readily sold and may remain on the books for a considerable amount of time.
2. Risk of loss
Every single investment carries with it the possibility of suffering a loss. Despite this, investments made via crowdfunding have the potential to be riskier than other forms of investments. This is because the majority of businesses that get investment via crowdfunding are still in their infancy and have not yet established a track record of success in their industry.
3. Potential for fraud
The Securities and Exchange Commission does not have jurisdiction over crowdfunding platforms (SEC). Thus, the likelihood of fraudulent behaviour is increased. Always conduct your research on a crowdfunding campaign before contributing any money to it.
4. The non-accredited investor may lose money
Participation in some types of crowdfunding initiatives is limited to only accredited investors. It is only the wealthy who have the financial means to take part in campaigns like this. Investors who do not have the necessary credentials face the danger of having their whole investment wiped out if the company fails.
5. Minimum investment amounts
There are occasions when a minimum donation is necessary in order to participate in crowdfunding campaigns. It is possible that this may need a financial spend that is beyond your capabilities.
6. Fees and expenses
Crowdfunding services will often charge fees in addition to other associated charges. These expenses have the potential to lower the return on investment that you get overall.
7. Limited information
Investors who participate in crowdfunding often lack fundamental background information about the companies they support. As a consequence of this information gap, it may be difficult to make an investment decision that is well-informed and suitable given the options available.
8. No guarantee of success
The capacity of a corporation to obtain cash is in no way indicative of the company’s future prosperity. Crowdfunding has been used by a number of enterprises that are now experiencing failure.
9. Dividends are not guaranteed
Companies that use crowdsourcing to obtain capital do not always make good on their commitment to pay back investors. This indicates that even if the company is successful, it is possible that you may not get any of your money back.
10. You may not get your money back
If the crowdfunding effort whereby the money was contributed does not succeed, there is a significant possibility that the money would be lost. However, the fact of the matter is that this is the case with every single kind of investment.
