Crowdfunding is an alternative finance model that companies can use to raise capital for the realisation of various kinds of projects. This form of financing has experienced a decisive expansion in the last decade, as a consequence of the credit crunch following the 2008 financial crisis and the development of the Internet and social networks with an exponential increase in online business opportunities.
Crowdfunding is characterised as a form of financing based on financial disintermediation and 'bottom-up' participation. This is a function of the possibility of investing in crowdfunding projects, which in this model is extended to both small and large investors.
Among the existing types of crowdfunding, equity crowdfunding and lending crowdfunding are increasingly popular. Let's see what they consist of and, most importantly, how these two types of investment differ.
How does equity crowdfunding work?
Equity crowdfunding consists of a financing method through which various investors can finance the raising of capital by private companies by obtaining company shares in return.
In this case, investing through the equity modality requires focusing on forward-looking companies, in terms of growth and development, capable of establishing themselves effectively in the market over time. This consideration, although not easy to foresee, is of great importance. In fact, in the event that the company is successful, the company shares acquired will take on a higher value, going on to generate a profit, while, if not, the risk is that of losing part or even all of what has been invested.
In the beginning, Italian regulations provided that equity crowdfunding was only intended for start-ups, while over time, the need arose to extend this method of financing to the category of innovative SMEs and in general to all small and medium-sized enterprises.
How does Lending Crowdfunding work?
Lending crowdfunding is an instrument through which a plurality of entities can request repayable funds for personal use or to finance a project from a plurality of potential lenders via online platforms.
In fact, lending crowdfunding allows investors to make their own funds available to finance projects of various kinds, often in the real estate sector, and in return obtain more advantageous interest rates than the norm.
Among the main advantages of lending crowdfunding are the fast application approval time, the high-interest rates offered to lenders and greater flexibility together with lower bureaucratic costs.
Until now, lending has operated without any form of authorisation or supervision. With the entry into force of the new European Crowdfunding Regulation, however, this form of financing is also placed within a clear legislative framework to protect both investors and the market in general.
What are the main differences?
The differences between the two types of crowdfunding, however, are decidedly more substantial than the commonalities. First of all, the mode of operation changes. With equity crowdfunding, the investor finances a company's project in exchange for shares, thus becoming a partner in the company he or she has chosen to finance. The company involved may be a start-up or an SME of services or products, or it may have as its purpose the development of real estate projects (in this case, we speak of real estate equity crowdfunding).
In lending crowdfunding, on the other hand, we are dealing with a real loan: the investor provides credit to a company (or private individual) that applies for it on the online platform. The loaned capital will then be paid back to him, plus a predetermined interest rate.
The different mode of operation of lending and equity crowdfunding also determines a different target group. Lending crowdfunding is used by companies that need liquidity quickly and without the intervention of intermediaries. The sums requested are usually not particularly high because they are intended for small transactions and investors, in return for the loan, receive the previously agreed capital and interest within deadlines that typically can vary from 6 to 12 months.
With equity crowdfunding, on the other hand, medium to large projects are usually proposed by more structured operators with a solid track record, involving different types of investors, both retail and professional. Remuneration in this case occurs at the conclusion of the project and the holding period can vary from 20 to 35 months.
Which one to choose?
Given the peculiarities of the two types of crowdfunding, we can try to establish in which cases it is appropriate to choose equity crowdfunding and in which others to choose lending.
Equity crowdfunding, which focuses on exponential productivity and growth rates, with profit margins depending on the success of the business, is more suitable for financing start-ups or SMEs.
Lending crowdfunding, on the other hand, is more suitable for real estate, as the investor's return is fixed and calculable in advance. It, therefore, involves less risk, as the gain is not linked to the performance and growth of a company over time, but to a specific project.