Start-up Financing: Types of Crowdfunding & their Benefits

There have been many initiatives in the last few years to boost entrepreneurship in Cyprus, and we already see many great start-ups here. More efforts are still needed to stimulate entrepreneurial initiatives in order to rejuvenate our society and accelerate innovation. A bigger emphasis should be given to the financing side, including the efforts to increase the number of providers of such financing and improve awareness among entrepreneurs of the available funding options. We outline in this article the features and advantages of such new type of start-up financing as crowdfunding, and we focus on equity-based crowdfunding as a promising funding opportunity.

So what exactly is #crowdfunding? Crowdfunding, or crowdsourcing, facilitates investments in start-ups via an online platform where a large number of individuals each invest a small amount of money in a new venture. Crowdfunding relies upon the easy accessibility of vast networks of people through social media and crowdfunding websites, to bring investors and entrepreneurs together. ?

Thus, companies or individuals can seek funds from a large crowd, via the internet, promising in return: 1) goods or services (reward-based type of crowdfunding), 2) shares in the company (equity type of crowdfunding), 3) certain payments in cash (debt-based type of crowdfunding, or crowdlending), 4) “feeling good about yourself” or essentially nothing (donation-based type of crowdfunding). We provide more illustrations to the types of crowdfunding in Figure 1 below.?

According to statista.com, in 2021, the global crowdfunding market was valued at almost $14 billion and was forecast to double by 2028, growing at compound annual growth rate (CAGR) of 11.2%. The two most popular crowdfunding platforms worldwide are Kickstarter (founded in 2009) and Indiegogo (2008). So far, Kickstarter has raised more than $5.6?billion spread over 197,425 projects.

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From its start less than 15 years ago, crowdfunding has grown to a huge industry. This is all due to the fact that it has multiple advantages over other types of financing available to start-ups.

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So what are the benefits of equity-based crowdfunding for entrepreneurs?

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First, relying on crowdfunding can help create brand awareness. Investors become customers and brand ambassadors for the company, as they learn more about the intrinsic quality of the company’s products. In other words, crowdfunding is not only about providing finance, but also about inducing those investors to become ambassadors for the company.

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The second advantage is that raising equity finance implies that the company will not have to make any extra intermediate payments, like interest payments.

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Another advantage is that the company is able to attract passive investors who are willing to hold on to their shares during at least four years, as per the rules in some countries, such as e.g. Belgium. The stake that each of those investors can accumulate in the start-up cannot exceed 30% in Belgium, which means that no outsider can take over control of the company. Very often, it becomes possible to obtain a loan from a bank, once the crowdfunding has enhanced the company’s equity base (and solvency ratio). Also, the fact that the company can convince other people to invest money and buy the product can create extra market validation, which can increase other investors’ faith in the viability of the company and its products. So, the crowd may provide credible evidence that there is a market for the company’s products.

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The last advantage is that it is a good alternative when it is hard for the company to obtain a bank loan; this is usually the case when a start-up is not making any profits yet. As for raising equity finance from institutional investors or via the stock exchange, it is often impossible for small and unprofitable start-ups.

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It is worth noting that the use of crowdfunding in different countries is largely dependent on the country’s legislation. The best effects can be seen so far in the UK, which has the most sophisticated crowdfunding market in the world today, thanks to the forward-looking way that the regulators there have engaged in the crowdfunding market.

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Belgium is another notable example of government efforts to promote crowdfunding. In 2015, the country adopted the so-called Tax Shelter. It allowed investors to reduce their amount of income taxes when investing in the equity of newly established businesses either directly or via a crowdfunding platform, while also limiting the risks of such an investment. In this way, crowdfunding had become an interesting option for both start-up companies and investors, provided that the company met certain conditions.

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Crowdfunding in Cyprus is regulated by the Cyprus Securities and Exchange Commission (CySEC) https://www.cysec.gov.cy/en-GB/legislation/services-markets/. The main aim of the local Crowdfunding Directive is to amplify the guidance and protection already provided to investors by the Investment Services and Activities and Regulated Markets Law. The local legislation is aligned with the EU Crowdfunding Regulation, and at the same time, the latter keeps developing. We should point out that the current legislation in Cyprus applies only to equity-based crowdfunding, while excluding other types of crowdfunding such as loans, rewards, or donations. CySEC emphasizes that investments in start-ups via crowdfunding platforms are of high risk.

On March 13, 2023, CySEC issued a Policy Statement on the application of the Crowdfunding Regulation essentially expanding the type of entities which can apply to operate as crowdfunding service providers and their scope and began accepting applications from prospective crowdfunding providers. Crowdbase is one such provider, and hopefully, we will see a number of Cyprus-based crowdfunding service providers being formed and gaining traction in the crowdfunding sector.

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*This article (including the figure) is based on the following publication: Huyghebaert, N., and Kandinskaia, O. (2021). Sizable: Crowdfunding Campaign! ... Again. Case Research Journal of the North American Case Research Association (NACRA) , 41(2), pp. 1-22. Available via Harvard Business Publishing https://hbsp.harvard.edu/product/NA0678-PDF-ENG (Received GOLD Best Case Award at the 2019 NACRA Annual Conference in Tempe, Arizona, US, and Best Published Case 2021 Award - ‘Tate Award’ by NACRA)