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Accessing business finance through traditional routes isn’t always an option.
Crowdfunding for business can be a game-changer. Whether it’s lenders tightening their criteria, offering too little flexibility or charging eye-watering interest rates, there are various reasons why businesses sometimes need to consider alternative funding routes.
In 2024, UK companies raised more than £300 million on crowdfunding platforms, enabling business owners to forge ahead with their ideas at both the startup and scaleup stages. Crowdfunding can also help small businesses, charities and social enterprises to raise brand awareness, as well as capital.
If you’re wondering ‘How does crowdfunding work?’, this guide is designed to clear up any confusion.
What is crowdfunding?
As the name suggests, crowdfunding involves sourcing finance from a ‘crowd’ of different individuals or organisations. For business owners, it’s a way to fund projects or ventures by raising money (potentially smaller individual amounts) from a large number of people.
You may have spotted crowdfunding campaigns on social media. Platforms like Crowdcube and Kickstarter are a popular way to match companies in need of cash with individuals keen to invest. This is how crowdfunding works; by providing retail investors like you and me, as opposed to professional investors, with a chance to back early-stage companies reliant on external finance.
The matchmaking is usually done through crowdfunding websites or platforms, where businesses can ‘pitch’ their project, business or idea and offer returns or rewards for those who pledge to lend or invest money.
The funding received by a business is sourced from multiple different lenders or investors, rather than a single entity such as a bank.
Four types of crowdfunding for business
Below are the most common types of crowdfunding for business.
1. Rewards-based crowdfunding
Rewards-based crowdfunding is where investors or lenders receive a product or service related to the project in return for the funding they have helped to provide.
Rewards might be physical goods, including limited edition products, gadgets, merchandise and accessories, digital downloads or exclusive experiences.
Brett Welch owns a microbrewery, Strangers Brewing, in Scotland and used rewards-based crowdfunding to help get his business started.
Crowdfunder Case Study
“We did a crowdfunder when we launched and raised £20,000 from a large number of small donations from £20 up to £1,500. This provided us with about half of the money required to buy the brewing kit.
Depending on how much they donated, the crowdfunders received different rewards (such as a case of beer, 10% off for 2 years) but no equity in the business itself.”
Brett Welch, founder of Strangers Brewing
2. Debt-based crowdfunding
In debt-based crowdfunding – also known as peer-to-peer (P2P) business lending – businesses set the amount they want to borrow and what the loan will be used for.
The P2P platform will work out the interest rate and how risky the loan might be. Meanwhile, investors plug in how much they want to invest and what return they’d like to earn.
If it’s a good match, your business gets the money. You’ll pay it back in monthly chunks with interest, similar to a typical business loan.
» MORE: Peer-to-peer lending
3. Equity-based crowdfunding
Equity-based or investment-based crowdfunding works on the same principle. The difference is that investors receive a stake in the business in return for their investment and so can share in the proceeds should the company be sold or floated on the stock market.
As Brett’s brewery business grew, he used equity-based crowdfunding to raise the capital needed to purchase the farm building he had been renting. Rather than using a crowdfunding platform, Brett leaned into his network of contacts to find investors willing to back his business in exchange for a minority stake. He applied for the government’s Seed Equity Investment Scheme (SEIS), which offers tax relief for investors who take a risk on an up-and-coming business.
“SEIS helped to cover some of the risk for the investors. They effectively received 50% of their initial investment back as a tax break, which made it a much easier sell for me,” said Brett.
» MORE: 16 Ways To Get Small Business Funding in the UK
4. Donation-based crowdfunding
There is also donation-based crowdfunding, where individuals give money to support the growth of your business without expecting anything in return. While it can be used by businesses, this is most commonly used by charities, community groups and non-profit organisations. However, it could still work for your business if it offers some kind of social or community benefit.
» MORE: Top 6 Crowdfunding websites
How to set up a crowdfunding page
Now you’re able to answer the question, ‘How does crowdfunding work?’, it’s time to get started by setting up a page on a crowdfunding platform.
Your page will tell investors and lenders how much money you need to raise and what you intend to use it for. You’ll want to include a persuasive marketing presentation that makes the case for your project or idea. This could include a short, accessible and compelling video presentation.
Each platform has its own guidelines, charges and criteria, while some will also specialise in certain markets. So it’s important to compare different sites and identify those most suitable for your needs.
What are the advantages and disadvantages of crowdfunding?
The broad benefit of crowdfunding is that it allows businesses and individuals to cut out the middlemen (i.e. banks and building societies) and go directly to investors. Crowdfunding enables you to link up with people looking for financial returns in exchange for giving money to support your business.
Crowdfunding is typically more flexible and sometimes cheaper than traditional options, so it can be quicker to secure funding. It also doubles up as a form of promotion for your business, which works well for social media marketing.
However, it’s not necessarily easy to secure funding and it can require a lot of effort to put forward a persuasive business case. You should also be prepared to answer questions from potential investors.
Different platforms also have different requirements and restrictions, such as minimum years of trading and credit rating criteria, which can limit the options available.
Each type of crowdfunding also comes with its own advantages and disadvantages.
For example, in equity-based crowdfunding, you are giving investors a stake in the business and by extension a degree of control over the future of the business.
In debt-based or P2P crowdfunding, you’re not handing over any ownership of the business to lenders, but there is a risk of damage to your business credit record if you are unable to repay the loan.
» MORE: What are business credit scores?
What are the alternatives to crowdfunding?
Funding options for businesses range from traditional business and start-up loans through to government grants, rolling credit facilities, asset financing as well as angel investors.
Each has different criteria and its own advantages and disadvantages, so it will depend on your individual circumstances as to which option is best for you.
» COMPARE: Business loans with NerdWallet
Dive even deeper
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by Tim Leonard