Crowdfunding is an emerging alternative form of financing that connects directly those who can give, lend or invest money with those who need financing for a specific project. It usually refers to open calls through the internet to the wider public to finance specific projects. Promoters of an initiative can collect funds directly. However, a web-based intermediary, a so-called ‘crowdfunding platform’, will often assist in publishing campaigns and collecting funds. While calls for funds to the public are not new, the phenomenon of using the internet to directly connect with funders emerged recently and brought significant visibility to this practice.
Crowdfunding can be used by different models of financing:
- donations are simple monetary contributions to help realise a project where nothing is offered in return
- rewards-based crowdfunding where those who contribute with money to the campaign get something in return, e.g. the cultural experience of appearing as an extra in the film they helped to finance
- pre-sales campaigns collect funds from the crowd to develop and produce a new product that will be shipped to the contributors
- crowd-lending refers to campaigns that borrow money from the crowd and promise to pay it back on certain terms either with or without interest.
- crowd-investing can take the form of profit sharing arrangements or investments into securities (debt or equity) issued by the firm that launched the campaign.
The two main categories to be distinguished are: crowdfunding with non-financial returns (donations, rewards and pre-sales) and crowdfunding with financial returns (crowd investing and crowd lending). The main difference between these two lies in the potential financial profit the latter model can offer and the specific investment risks attached to it.
The practice is becoming more and more wide-spread since the financial crisis, as banks’ lending activity is reduced and access to finance is more difficult. Industry estimates show that almost half a million projects were financed through crowdfunding across Europe during 2012, raising €735 million, 65% more than in 2011. The forecast for 2013 is €1 billion.
This figure is promising compared to the financing provided by business angel investors (visible market segment estimated by the Centre for Strategy and Evaluation Studies at €660 million in the year 2010) or venture capitalists in seed, start-up, later and growth stages (€7 billion in 2012 according to EVCA), although it remains modest if compared to the European retail bank lending to non-financial institutions (€6 trillion in 2012 according to EBF).
The European Commission recently conducted a public consultation to explore how EU action, including a range of soft-law measures, could promote crowdfunding in Europe. Stakeholders responding to the public consultation identified some of the key challenges that need to be tackled for crowdfunding to flourish. These include a lack of awareness and understanding, lack of information concerning the applicable rules, risks of insufficient or misleading information disclosure, the functioning of crowdfunding within the Single Market and the issue of matched financing (a full summary of the responses can be found here). In order to address these issues and exploit the full potential of crowdfunding in the EU, the Commission will:
- carry out a study to explore market developments and the potential of crowdfunding to finance research and innovation
- raise awareness, provide information and training modules for project owners, especially for financial return crowdfunding (crowd lending and crowd investing)
- encourage exchange of industry best practices and standards, and facilitate the development of a European 'quality label' to build trust with users
- establish an expert group, called the European Crowdfunding Stakeholder Forum, that will advise the Commission on some of the above actions
- assess the possibilities for using public funds to support projects through crowdfunding
- hold regulatory workshops with national regulators to discuss obstacles to convergence of national regulations on financial return models and, where relevant, issuing recommendations to encourage Member States to avoid inconsistencies in national approaches
- closely monitor the market and legal developments and regularly assess whether further EU action is needed.
Crowdfunding has real potential to finance different projects, such as innovative, creative and cultural projects, or the activities of social entrepreneurs, that have difficulties in accessing other forms of financing. It could thus contribute to bridging the finance gap for innovative projects and usefully complement other sources of finance. Better access to finance for social entrepreneurs would promote the movement and ultimately contribute to growth and job creation. One study estimates that in Spain alone 7,500 direct ‘crowd-jobs’ were created through some 2,800 successful crowdfunding projects.
For more information on crowdfunding and the European Union's role in the movement, please review the European Commission's recent communication.