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What Should We Know About Crowdfunding?

The last few years have seen crowdfunding projects around the world grow in popularity. It was estimated that in 2015, more than US$30 billion was funded through crowdfunding worldwide. Even Singapore has had its fair share of crowdfunding projects.

Companies such as Shenton Wealth and Fundedhere have structured products that allow investors to invest small amounts of money in startups or singular projects. In light of these events, I thought it might be a good time to outline some crucial details about crowdfunding.

What is crowdfunding?

The term crowdfunding refers to companies raising funds via a large number of individuals. There are four types of crowdfunding available.

  • Donation-based crowdfunding

Individuals may pool their money to donate to a charitable cause. It can also mean donating to a start-up that the individuals wish to support. One such website that supports this type of crowdfunding is the Kickstarter website.

  • Reward-based crowdfunding

Investors support a company in exchange for products or other forms of rewards. For example, an individual may support a company before it launches its products in exchange for the company’s product when it eventually launches. There is no monetary reward for investors in this case.

  • Lending-based crowdfunding

Investors lend money to a company and the company agrees to pay back the loan with interest.

  • Equity-based crowdfunding

Investors provide the company with funding in exchange for equity. This is similar to venture capitalist, but investors can invest much smaller amounts in the company

Key risks when considering crowdfunding

As with all investments, crowdfunding poses some risks to investors. It is important that investors take note of these risks before deciding on this type of investment.

  • Loss of capital

When investing in small companies, the risk of capital loss is extremely high. Investors need to take note of the company’s finances and ability to generate profits in the future.

  • Risk of fraud

There have been numerous instances of investors losing their money due to fraud. Crowdfunding companies may raise funds without any real use of the money. Investors need to be extremely cautious not to fall for any of these traps. A good way to spot fraud is when investors are promised returns that are too good to be true. This is a major red flag.

  • Liquidity risk

Unlike stocks that are traded on an exchange, equity in companies cannot easily change hands. There is also often a lock-up period for lending-based crowdfunding.

  • May not be regulated by MAS

The Monetary Authority of Singapore (MAS) does not regulate many of the crowds funding platforms. Investors need to be careful when dealing with such entities.

The Foolish bottom line

Crowdfunding has gained popularity in recent years as it gives individual investors access to investing in start-ups and individual projects that were once unable to invest in. Furthermore, some of the crowdfunding investments promise exceptional returns over a short span of time.

Having said that, crowdfunding does have its own risks. Investors need to be extremely cautious not to expose themselves to too many risks. It is therefore important that investors do sufficient due diligence on crowdfunding investments before making a decision.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.