How crowdinvesting helps small businesses and startups
Crowdinvesting is a modern way of raising funds for startups and small businesses, where anyone can become an investor by contributing a small amount through an online platform. It allows individuals to support promising projects and earn returns that were previously only accessible to large investors. However, it is not all straightforward; alongside the potential for high returns come high risks. Let’s explore how this mechanism works and its main advantages and disadvantages.
Crowdinvesting: what is it and how does it work
Crowdinvesting is a collective financing model whereby numerous individuals invest funds into various projects or companies via specialised online platforms. This mechanism helps attract capital for startups and small enterprises that face difficulties obtaining financing through traditional channels, such as banks or venture capital funds.
Crowdinvesting occurs through online platforms that connect entrepreneurs seeking investment with private investors. The process involves three stages:
- Project presentation: A company in need of capital presents its project on the crowdinvesting platform, outlining its goals and investment conditions.
- Investment: Investors select a project and contribute their funds, forming a pool of investments. Unlike traditional investments, the minimum amounts can be relatively small.
- Return on investment: Investors can receive returns in the form of dividends, interest, or profits from the sale of shares in the company. The form depends on the crowdinvesting model (equity, crowdlending, or royalties).
What sets it apart from venture capital
Venture capital focuses on large investments from professional investors or funds. Crowdinvesting allows small contributions from many people. This expands startups’ access to financing and allows investors to earn returns from promising projects without the need to invest large sums.
Types of crowdinvesting
Crowdinvesting offers three investment options, suitable for different types of projects and investors’ goals.
Crowdlending
Crowdlending is a form of lending where investors loan money to a business or startup with the expectation of repayment with interest. This model is attractive for small businesses that require short-term financing for specific tasks, such as purchasing materials or expanding production.
The main advantage is the potential for rapid return on investment, although the risk of non-repayment is high.
Equity crowdinvesting
In equity crowdinvesting, investors acquire a share in the company, becoming co-owners. This form of crowdinvesting is popular among startups and companies that are in the early stages of development but have growth potential.
Investors can expect to receive dividends or profit from selling their shares in the future if the company’s value increases. However, this type of investment is associated with a long payback period.
Royalty crowdinvesting
In this model, investors receive a percentage of the company’s revenue. Royalty crowdinvesting differs from crowdlending and equity crowdinvesting in that the return on investment depends on the business’s profitability, rather than a fixed debt amount or ownership share.
This is a flexible option that attracts investors willing to share risks with the business and hoping for passive income from its activities.
Advantages of crowdinvesting
The advantages of crowdinvesting include access to capital for small businesses and startups, diversification for investors, simplicity of the process, and potentially high returns.
Access to capital for small businesses and startups
Crowdinvesting enables small businesses and startups to raise funds without the need to turn to traditional investors or banks. This is beneficial for young companies that lack sufficient credit history or collateral to secure a bank loan.
Diversification for investors
Investors can distribute their investments across multiple projects, minimising risks. They can engage in a variety of projects and increase their chances of successful investments.
Simplicity of the process
Unlike traditional forms of investment, crowdinvesting requires minimal documentation and formalities, making the process quicker and more accessible to a wider audience.
Potentially high returns
Investments in startups and new projects can yield significant profits if they develop successfully. Investors have the opportunity to acquire stakes in growing companies with the prospect of increasing share value.
Disadvantages of crowdinvesting
There are four main disadvantages of crowdinvesting: high risks for investors, lack of regulation and rights protection, limited liquidity, and low public awareness and trust.
High risks for investors
Investing in crowdinvesting projects comes with significant risks. Startups and small businesses are financially unstable. Over 90% of startups do not survive their first year, leading to a total loss of invested funds. Risks are compounded by the lack of success stories or financial data from such companies, making it difficult to assess their viability.
Lack of regulation and rights protection
In several countries, crowdinvesting still lacks a clear legal framework. This creates a space for fraud or abuse by companies that neglect their obligations to investors. Due to the absence of regulation, investors remain unprotected if a project fails.
Limited liquidity
Investments made through crowdinvesting are not easily withdrawn or sold until the project is completed. Unlike the stock market, where shares can be sold at any time, it is not possible to exit a crowdinvesting project quickly. This makes such investments less liquid and less flexible for investors.
Low public awareness and distrust
Crowdinvesting remains a relatively new phenomenon for the general audience. Insufficient awareness leads many investors to misunderstand the risks and potentially participate in projects that do not meet their expectations or investment goals.
