The differences between donation-based and equity crowdfunding

Business Plan Consultants What’s the difference between donation-based and equity crowdfunding? Expert venture capitalist consultant Todd Smith weighs in.

When people ask us here at Blue Horizon Venture Consulting how to start a business, it seems the issue of financing a new company is always at the forefront.  As the old saying goes, "it takes money to make money".  While it is certainly possible to get a new company going on a shoestring budget, it's still going to require some capital - even if you can start it in your garage using equipment you already have.  Unless you're an expert at everything, you're likely going to need to hire some help - either employees or outsourced professionals.  You're likely going to need supplies, phones, fax machine, a printer, and the Internet.

So, one answer we give our constituents is: crowdfunding.

But there seems to be a significant amount of confusion and misunderstandings about what crowdfunding is and how in works.  Very simply, in can be broken down into two categories: donation-based crowdfunding and equity crowdfunding.

Donation-based crowdfunding is rather simple.  Company A uses a donation crowdfunding portal like Kickstarter to build a crowdfunding campaign - typically a catchy video along with a pitch and some kind of "rewards" offering - ranging from a bumper sticker or t-shirt for low end donations to one of the first products created by the company or an all expenses paid trip to company HQ to meet the founders and have a VIP kickoff party.

Most of these campaigns get very little funding, but every once in awhile, a campaign will go viral and generate hundreds of thousands or even millions of dollars in donations.

The Pebble Watch is a great example.  The founders went on Kickstarter hoping to raise $100,000 after burning through a good portion of their capital trying to grow their fledgling company.   Their smart watch, which enabled wearing to receive email and other notifications quickly caught fire on Kickstarter an 69,000 donations later, the company had raised $10 million!

For product-based companies, this can essentially be a way to pre-sell the company's products.  Donor B "donates" say, $1000, and Company A reciprocates by "rewarding" Donor B with one of their products, let's say a feather-light bicycle made with composite material.  Or Donor C donates $5000 to the making of an independent film and Company D reciprocates by "rewarding" Donor C with a one-line speaking part in the film and a credit.

Equity Crowdfunding is an entirely different animal and is relatively new to the scene, having just been approved by the SEC for accredited investors only in late 2013.  The JOBS Act legislation, which effectively paved the way for equity crowdfunding in the United States, is also slated to be opened up for ALL investors (i.e., non-accredited investors) as soon as the SEC can create a set a rules that will protect investors, while at the same time not placing too large a burden on the small companies trying to raise capital.  The SEC continues to drag its feet trying to implement these rules, but it should happen soon.  When it does, and if it's actually a reasonable way for small companies to raise money, we'll see a huge change in the way businesses are financing, and likely significant disruption in the financial sector (to the benefit of companies and investors at the expense of the current intermediaries). The distinction to make versus donation crowdfunding is that by contributing capital to a company, that person is not a donor, but an investor who receives shares of stock, ownership units, or some other measured return on their investment.  So equity crowdfunders go along for the ride and share in the company's future success.

So, imagine, if you will, that both forms of crowdfunding were around when Mark Zuckerburg and friends started Facebook at Harvard. Under the donation-based scenario, the $100 donor might get a Facebook t-shirt and a high five from Mark personally.

Under the equity scenario, let's say that same person got 100 shares of original Facebook stock. Facebook ownership since went through many gyrations and changes over the years before going public, but for the point of comparison, let's say that owner still had 100 shares of Facebook.  At approximately $73/share, that $100 investment would now be worth $7,300!

Time will tell what happens to the future of both forms of crowdfunding, but the promise of future returns sure beats the "I invested $100 and all I got was this crappy t-shirt".


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