Crowdfunding is the raising of funds through the collection of small contributions from the general public (known as the crowd) using the Internet and social media.
The Donation Model: Individuals make a financial contribution to a project without any expectation of a financial return on that contribution. Projects and platforms that employ the donation model typically also use a reward or incentive system to help stimulate contributions whereby contributors are thanked for their support with a small reward. Rewards or incentives vary from recognition in the project’s credits to branded merchandise or opportunities to meet with creators and/or attend special events such as a launch party or premiere screening event. Rewards or incentives often increase in number and/or value in accordance with the amount of the contribution being given.
The Lending Model: This crowdfunding model is similar to any typical lending scenario, where individuals lend money to a project or company with the expectation that it will be repaid. In the context of crowdfunding, the lending model can take a number of forms, such as:
- A traditional lending agreement – standard terms are used and there is an expectation for a monetary reimbursement in the form of interest. In this case, the loans may or may not be guaranteed, depending on the crowdfunding platform being used.
- A forgivable loan – contributions are reimbursed to the lender only if one of two possible conditions is met: a) if and when the project begins to generate revenue or b) if and when the project begins to make a profit.
- Pre-sales – the finished product is promised in return for the contributor’s pledge. In the case of a pre-sale lending model, the contribution amounts are determined according to an assessment of the fair market value of the product. In addition, larger contribution amounts are typically accompanied by a promise of more copies of the product equal to the value of the amount of the contribution. Pre-sales are often combined with a rewards-based donation model.
The Investment Model: Resembles a standard equity investment, where an individual receives equity in an entity in return for financing. There are two standard sub-categories of Investment Model crowdfunding:
- Securities Investment Model – shares in the company are bought by investors. In this model, contributors would be buying ownership in the parent company or rights in a project.
- Profit or Revenue-sharing Model – a share of the revenue or profits of the project is earned by investors, as opposed to shares in the underlying company. This is also known as a ‘Collective Investment Scheme’.