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what is crowdfunding?

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Crowdfunding is an alternative form of financing to traditional methods such as loans or grants. It is a method of collective financing, in which several people invest the amount of money that each one wishes in the project that one person has made public. In fact, the term Crowdfunding is made up of the word crowd and Funding ( financing, funds).

What does crowdfunding consist of:

Investment Scrabble text

Precondo CA via Unslpash

Crowdfunding was born at the end of the 20th century, as a consequence of the development of the Internet and the wide range of possibilities that technology offers. Usually, these funding processes are carried out on specialised websites. The process follows a series of steps that begin when a person, group, collective or society makes public its need for funding on a platform or network. The following details appear in this request:

  • The project to be carried out, or that is already being carried out,is explained
  • The values, the context, the history behind the project, if there is any.
  • The objectives to be achieved with the funding are detailed
  • The path that has preceded its creators to get to this point.
  • It specifies how much the funding amounts to, and how much of that total the creators are requesting through the platform.
  • It includes the time dedicated to fundraising, i.e., until what day the funding remains open and what is the last moment to make investments.
  • Theconditions for investment, which vary depending on the content of the project and the agreement on the return of the funding, if any,are made clear.

This form of financing was born with the subtle tinge of the common good. Although, today, it could be extended to any type of project, it became popular in investments whose purpose was to participate in an action that was beneficial to the common good. Those investments with a social touch were the ones that most stirred the hearts of individuals without large amounts of money, and motivated them to contribute part of what they had to advance the cause of others. This form of investment would never have gone ahead if it had not started in a social and ethical way.

The most revolutionary aspect of this funding model is the democratisation of investment. Until the emergence of the internet, only people with high incomes and prosperous businesses could invest and grow their savings. Now, with the internet and tools such as crowdfunding, anyone can become an investor and grow their savings by supporting projects they truly believe in.

Types of crowdfunding:

Over time, the technique has evolved into four different types of crowdfunding:

  • Donation-based: These are donations, in the traditional style, where you donate part of your money to an external cause or project. The only return on this investment is the satisfaction of seeing a project that you believe is necessary go ahead.
  • Reward-based: Reward means reward or prize. In this type of crowdfunding, the investor obtains a non-monetary reward, for example, appearing in the credits, acknowledgements, free entrance to the presentation event...
  • Equity-based: The investor gets an amount of money in exchange for participation in the project. It is not in the form of interest, but in the form of shares. Depending on the amount invested, each person will get a percentage of the shares of the company or project. This is one of the forms of crowdfunding that most resembles the traditional investment mode, because whoever decides to participate becomes, in some way, an owner of the company (to a greater or lesser extent). However, he or she does not receive a classic return on investment, usually in the form of interest, but the amount invested is equated to a part of the total of the company.
Tipos de crowdfundingJeremy Bezanger via Unslpash

This type of investment creates a bond between the investor and the project that goes beyond the moment of the investment, as was the case with the two previous ones. In the two previous cases, once the money was deposited, the person who had decided to invest could almost forget about it, as he or she had nothing more to put into it. But this type of investment is riskier, although it can also be much more profitable .

Once someone owns part of a company's shares, it may be possible to sell that stake at a time when the group is worth more than it was when the person first invested in it, and thus make a profit on the investment. Or the opposite may happen, and the shares may need to be sold at a time when the value of the share is less than it was when the investment was made.

While it is true that in the two previous cases no part of the investment was returned, on this occasion it is expected that all of the investment will be returned. In fact, those who opt for equity-based financing usually expect to sell their shares again to obtain a return on the investment, so that selling for less than the amount invested has the opposite effect to that desired and is a risk that must be known and accepted at the time of the investment.

  • Loan-based: This form of financing is also known as crowdlending. Loan means loan, i.e. the amount invested is expected to be repaid. This could be an equity-based model up to this point, but the way in which the loan is repaid in this case is in the form of interest .

The interest rate is previously detailed and agreed between the parties once the investment is made, and does not usually vary, except in exceptional cases. To calculate the interest rate, the average of all the lowest interest rates offered by the investors until the planned investment has been completed is taken. If this average rate is less than that offered by the investor, the interest rate initially requested by the investor is respected.

The success of this type of collective investment is due not only to the democratisation of investment, but also to the fact that they have proved to be less risky and more successful than traditional investments.

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