Wed. Nov 25th, 2020

Planet Compliance

Innovation & Regulation in Finance

What is Crowdfunding?

3 min read

Basically, Crowdfunding is a just a type of financing. Described as the “pennies from the many” model, it’s key differentiator is that the money is raised from a large number of people, often through internet platforms that mediate and manage the process. Thus, Crowdfunding needs at least two participants, i.e. the initiator who proposes an idea or project on one side and individuals or groups that financially support it, or three in most cases where the platform brings the two together. Traditionally, the ideas funded in this manner were creative projects, it has grown to raise funds from donors to support a variety of activities, amongst them product development and businesses.
A distinction is drawn between two types of Crowdfunding:

  1. The donation based model that includes rewards crowdfunding and charity crowdfunding. Rewards-based means that contributions are exchanged for current or future good of services, the typical example being a band that produces an album and in exchange for the funding give their donors a t-shirt, a copy of the cd or simply a big thank you. Charity crowdfunding simply refers to the activity where an individual or an organization such as a non-profit accepts charitable donations.
  2. Investment based crowdfunding on the other hand, which has become more and more prominent in recent years, sees an exchange of money for some form of securities. Again, a distinction can be drawn between lending crowdfunding and equity crowdfunding. In the first case, the crowd lends the money to the initiator of the project or a company and expects that the loan will be repaid with interest; this is what generally is referred to as Peer-2-Peer Lending or, more recently, Marketplace Lending to reflect the shift from small investors to large ones like institutional investors. The second case, refers to the practice where the crowd receives ownership in the company in the form of equity.

In conclusion, the second type of crowdfunding, the investment based crowdfunding is very similar to the more common kinds of debt and equity investments, with similar kinds of risks and mechanisms. However, since it is only similar but not necessarily the same in all aspects, existing securities laws in the different jurisdictions often covers the activities only partially or non in an adequate way. This has led to reviews of the regulation in force and the proposal or introduction of new legislation in most jurisdictions, which will be subject of separate articles.

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