Crowdfunding is a type of crowd investing that collects funding from a “crowd” of retail investors, usually via an online platform. Unlike crowd-donation, crowdfunding or -investing collects funds from retail investors who can expect a return on their investment. Hence, it is a type of loan product, where interest needs to be paid. Thus, it is based on lending or reward-based models and investors can freely pledge their capital to projects they wish to support. In principle any project that can raise enough attractiveness can be crowdfunded. The municipalities benefit from community participation, can freely decide on the return on investments and split their finance in regular ways of funding and crowdfunding. However, the municipality owes responsibility to a large number of small investors and runs the risk that the investors do not stick throughout the funding phase. This type of financing instruments is best suited for small scale investments (Novikova, A. et al, 2017).
Advantages: While the prospect of financial returns provides some motivation, in most cases people contribute to a specific campaign because of their interest in the project. Hence, a major benefit of this source of capital is actually the communication, engagement and visibility around the project, rather than the large amount of capital or high return. Crowdfunding creates a community around the project; and as a result, people can become engaged in the process and provide insights and ideas that are useful for project development. The project may attract more investors if a portion of the required finances have been raised through crowdfunding.
Disadvantages: As with any type of financing model, crowdfunding has risks. For example, there is no guarantee of sufficient funding being raised, it requires a high up-front development process, problems with the crowdfunding platform may arise, investors may be inexperienced or wish to exit, the process is not regulated (often dependent on national legislation) and it may be challenging to fulfil commitments to a multitude of small investors.
From the investor’s point of view, the risks include the loss of a portion of the capital or failure to obtain the expected returns, the lack of a secondary market, insolvency of the platform operators and misinformation or insufficient information to price the invested securities correctly (European Commission 2016).
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References:
Novikova, A., Stelmakh, K., Hessling, M., Emmrich, J., and Stamo, I. 2017. Guideline on finding a suitable financing model for public lighting investment: Deliverable D.T2.3.3 Best practice guide. Report of the EU-funded project “INTERREG Central Europe CE452 Dynamic Light”, October 2017.
European Commission 2016. “Crowdfunding in the EU Capital Markets Union. COMMISSION STAFF WORKING DOCUMENT.” https://ec.europa.eu/info/system/files/crowdfunding-report-03052016_en.pdf.