Crowd funding explained

Posted on June 03, 2014 by FGL

Crowd funding is not new - for example the Statue of Liberty was crowd funded in 1885 - but the internet has made the process much more accessible and it is really taking off.

I was intrigued by Crowd funding when I first heard about it – especially as my initial thought was “is someone going to pay me to go to an England match!” Sadly, no – but what I found out was definitely worth sharing, so I’ve asked Dave Farmer at Lime Consultancy (just voted Crowd funding Specialist of the Year 2014) to write a guest blog.

What Is crowd funding?

Way back when Lloyds of London started insuring ships they were asked to insure the first cars. Puzzled by this, they decided to define a car as ‘a ship which navigates on land’. Today the word ‘car’ is information enough.

Crowd funding is going through a similar journey. The thing is that crowd funding is far from new; the first crowd funding project was back in 1885 and financed the building of the Statue of Liberty. However, it was not until the availability of the internet that crowd funding really took hold.

The perfect storm

Crowd funding in the UK has grown out of a perfect storm of savers wanting a better return on their money and businesses wanting access to lending. In its simplest basis, crowd funding is merely a method to bring savers and borrowers together. This creates a ‘crowd’ of people who collate their money and lend it to a business who has asked to borrow.

Types of crowd funding

There are three main types of crowd funding. equity, debt and reward.

  • Equity - the business sells a stake in it to raise finance. The ‘crowd’ put the money in and receive a dividend as payment
  • Reward - the crowd put money into a specific project. They do not take a financial benefit but receive a reward instead. This is common with more innovative products, films or inventions. Very much ego based or philanthropic, the reward could be anything from a prototype product to being invited to the film premiere.
  • Debt – this is by far the biggest sector. These are normal loans, the money for the loan coming from the crowd and the business has a single loan agreement with the crowd funder to whom they make the repayments. All the crowd funder does is administer the process.

The benefits of crowd funding

The growth in crowd funding has been immense. Next year will see over £1bn having been lent to UK businesses through this avenue. Serious stuff.

The benefit comes from the spread of risk.

If you go to your bank and ask for a £50k loan, but then if it all goes wrong, your bank have a potential £50k bad debt. Because of this banks are cautious: they want you to give security and, when times are hard, they become even more risk averse.

With crowd funding, the £50k could be split amongst 1,000 different savers, each putting in £50. With the individual risk being much lower, the appetite to lend becomes higher. If your friend asked you to lend him £50,000 for his business, you may back away as the risk would be too high. But if he asked for £50 or £100, you may be willing to do it. This is how crowd funding works; each saver has an acceptable level of risk, when combined together with the rest of the crowd, the business receives its money.

The cost of crowd funding

Cost is based on risk, the same as normal. But at rates from 6%, crowd funding is competitive. Add to that an answer inside 48 hours and funds in 72 hours, then you start to see why it is growing so fast.