Crowdfunding can get projects off the ground but some may fail to rise.

Without crowdfunding, the Statue of Liberty might not be standing sentinel in New York harbour. The French government donated the statue but Americans were left to raise money for the pedestal. The famous publisher Joseph Pulitzer launched a fundraising campaign in 1885 through his newspaper The New York World. It raised US$101,091 in five months from over 160,000 donors.

Crowdfunding works by having many people – the crowd – put in small amounts of money to support a project. The internet has taken crowdfunding to a new level. The global financial crisis of 2008 also contributed to crowdfunding growth – especially equity crowdfunding and peer-to-peer lending – when regular sources of personal and business finance dried up.

Worldwide $3.3 billion was raised by crowdfunding campaigns in 2012, nearly doubling in growth from the previous year.

Types of crowdfunding

There are different types of crowdfunding. Social crowdfunding and equity crowdfunding are the most common. There’s also peer-to-peer lending, which is sometimes referred to as debt crowdfunding.

What they have in common is access to capital to those who can’t get, or don’t want to get, funds through traditional means such as banks and finance companies. Funding is left to “the crowd”, bypassing the financial middlemen and usual decision makers.

Social crowdfunding

Social crowdfunding has stepped in where traditional fund sources like banks, club members, arts patrons, or family and friends aren’t enough to get a project off the ground. It can be split into donation-based and reward-based models.

Donation-based crowdfunding is when people give an online donation or pledge – a charitable gift – to a project or cause. It’s not much different from giving money to a charity fundraiser in the street.

Reward-based crowdfunding offers an incentive or reward for your contribution. The rewards offered may differ according to the amount donated. The fundraiser usually has a target amount they want to raise.

Equity crowdfunding

Equity crowdfunding allows a private business to raise funds from the public, with investors receiving shares (equity) in the business. The amount an investor owns is proportionate to their level of investment.

Equity crowdfunding became subject to financial regulations in April last year. Companies looking to raise funds must use a licensed equity-crowdfunding provider. The Financial Markets Authority (FMA) is responsible for licensing.

How does it work?

Fundraisers choose a crowdfunding platform that suits their project and audience. Usually the platform will review the project before accepting it to be sure it fits its criteria.

Once they’ve been accepted the fundraiser makes a pitch on the platform’s website. On a reward-based platform they’ll outline the rewards or incentives for different levels of donation – for instance the donor’s name in movie credits, or early access to the product they’re developing.

The fundraiser then spreads word of their campaign. Those who want to support it can use the platform to pay by credit or debit card, or sometimes bank deposit or PayPal.

Depending on the crowdfunding platform either the fundraiser gets everything donated (less fees) or they get nothing unless a target amount is reached. If it hits or goes over target the fundraiser gets it all (less fees). If the target isn’t reached the donor pays nothing.

Most platforms have fees; usually a percentage of the total amount raised (the “success” fee) plus transaction fees. When these are combined, they could add up to 10 percent of the total amount raised. That’s how a platform makes money and covers expenses.

Equity crowdfunding platforms may also have application fees that a business has to pay, whether it’s successful at raising funds or not.

Crowded market

There are hundreds of crowdfunding platforms, although not all are open to New Zealand-based projects.

Donation-based platforms

Boosted, Givealittle, and FundraiseOnline are New Zealand platforms.

  • Boosted was set up in 2013. It specialises in arts projects and is backed by The Arts Foundation, a Kiwi not-for-profit organisation with charitable status. Donations made through Boosted can be eligible for a tax credit.

  • Givealittle started in 2008 and was taken over by the Spark Foundation (formerly the Telecom Foundation) in 2012. It has a wide range of categories that potential donors can explore. Givealittle has no fees – its costs are covered by the Spark Foundation.

  • FundraiseOnline started in 2004 and specialises in events fundraising. It’s aimed at charities, not-for-profit organisations, schools and clubs wanting to raise funds.

Donations through Givealittle and FundraiseOnline can also be eligible for a tax credit if the fundraiser has charitable status here.

  • GoFundMe is a US platform but New Zealanders can use it to fundraise for anything and everything. Donations can only be made in US, Canadian or Australian dollars, euros, and UK pounds through PayPal or credit card. The donor will pay the currency conversion fee.

Reward-based platforms

  • PledgeMe Projects, which began in 2012, is a New Zealand reward-based platform. Individuals, groups and organisations can use PledgeMe to raise funds for projects.

  • Kickstarter, one of the most well-known crowdfunders, also accepts New Zealand projects. It originated in the US in 2009. It’s been open to New Zealand projects since 2013. It’s aimed at creative projects, not fundraising for charity.

  • Indiegogo is another US platform that Kiwis can use. It offers both reward- and donation-based crowdfunding. Donations can only be made in US, Canadian or Australian dollars, euros, and UK pounds through PayPal or credit card. The donor has to pay the currency conversion fee.

Donations through reward-based platforms will only be eligible for a tax credit if the fundraiser has charitable status here.

Equity crowdfunding

PledgeMe Equity, Snowball Effect and Equitise are the three active platforms out of the four currently licensed.

  • PledgeMe Equity has successfully raised funds for two businesses since being licensed – including for itself, so it can build its team and create a better website for mobile use. It set a target of $50,000 and raised $100,000 from 50 pledgers with a minimum investment of $500. These people are now the owners of a 14.3 percent share of the company. PledgeMe’s board has committed to paying dividends “when it would be prudent to do so”.

  • Snowball Effect has raised around $2 million for three businesses since its launch in August 2014. It was used to raise money to help make a Kiwi film, The Patriarch, based on Witi Ihimaera’s novel Bulibasha. The filmmakers set a target of $300,000 and raised $488,800. In return for a minimum $100 investment, these 204 investors are first in line to recoup both their capital plus a 20 percent per annum premium from net income if the film is commercially successful. They’ll also receive a percentage of further available income once lower ranking investors have received their return. In addition, individual investors will receive rewards based on their level of investment: a $50,000 investment gets the investor an invite to the premiere of the film as well as all the lower-level rewards.

  • Equitise has just listed its first equity crowdfunding campaign for TRNZ Digital Travel Guides.

  • Crowdcube, a UK based company, is the other licensed equity crowdfunder but it is yet to list any projects in New Zealand.

Risks and returns

The returns for social crowdfunding donors can be as intangible as feeling good about helping or as tangible as receiving a product.

But social crowdfunding is a model that works on trust and transparency. Platforms may do basic checking of fundraisers and recipients but fraudulent fundraising can still happen. However, the openness and social media involvement of crowdfunding can also mean fraud is spotted early by potential donors.

The major risk for donors is they don’t receive the reward they were promised, or they’re disappointed when a target isn’t reached or project completed. The crowdfunding platforms take no responsibility for how funds are used or whether rewards are delivered.

If you donate through a platform that uses an all or nothing arrangement, your money is usually safe. Either the donors aren’t charged unless the target is reached, or the platform holds the funds and returns them. But platforms which hand over anything that’s raised provide no such safety. Some allow the fundraiser to withdraw funds as soon as donations are made.

Equity crowdfunding allows everyday investors to back a private business and own shares in it. As well as feeling good about supporting a business, the investor could even receive a return on their investment.

But companies raising money through equity crowdfunding don’t have to provide detailed investment or financial statements (as they would with a regular public share offer). Nor do they have ongoing reporting requirements. The potential investor has to make do with the information provided on the platforms, and do their own checking. The FMA doesn’t check the companies: it only checks and licenses the crowdfunding platform (see 'Regulation', below).

The success of the platforms will be linked to the quality and success of the companies they accept. It’s in the platforms’ interests to assess the companies carefully.

The key risk is that the company doesn’t perform and is unable to deliver the expected returns. As crowdfunding is popular with start-up businesses, this risk can be significant. And even if the business does survive and thrive it could be years before it can pay dividends. The FMA can’t help get your money back if the company fails or doesn’t grow.

There’s also no secondary market yet for investors to sell their shares. And there’s the possibility of “dilution risk”: if a company issues more shares to raise more money, this reduces the value of your investment.

The FMA has more information on equity crowdfunding.

Report by Kate Sluka.