4 Crowdfunding Models Your Startup Can Use to Raise Capital

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Have you been thinking about using a crowdfunding model to launch your startup? Then you may want to understand the 4 basic types of crowdfunding models and the financial and legal implications of each one.

Before you go online and start asking friends and family for money, get yourself up to speed on the various crowdfunding models available and the benefits and drawbacks of each.

The Four Basic Crowdfunding Models

The Crowdfunding models are distinguished by what the contributors are given in exchange for their investment. There are different websites that specialize in each
of these crowdfunding models.

The main crowdfunding models these sites use include:
1.The donation based model
2.The pre-purchase model
3.The lending based model
4.The equity crowdfunding model

Keep in mind that some sites use a hybrid crowdfunding model. This is most common with the donation and pre-sale crowdfunding models.

The Donation-Based Crowdfunding Model

As the name suggests, donation crowdfunding sites allow contributors to donate to causes or projects they care about. Contributors are not offered a product or an ownership stake (equity) in a company for their donation. Donors give for a charitable reason to help out a project they feel passionate about.

One example of a donation based crowdfunding model in action is CrowdRise. CrowdRise is the world’s largest charitable crowdfunding site. The site allows anyone to fundraise for charitable or personal causes. Hundreds of millions of dollars have been raised in the past few years on this site alone.

While the donation crowdfunding model can sometimes be used by innovative small startups, it is generally not suitable for a for-profit business start-up.

The Pre-Purchase Crowdfunding Model

The pre-purchase crowdfunding model allows you to sell your product before it has even been created. You do need to have a concept and the ability to fulfill orders within a reasonable amount of time. On sites like Kickstarter and IndieGoGo you can take orders and payments for the orders and offer products and rewards to purchasers before you build your product. The payments for the orders can be used to produce the products.

This is the most common form of crowdfunding model out there today.

The Lending Crowdfunding Model

The lending crowdfunding model allows contributors to give small, usually short term loans. The leading site for this Crowdfunding Model is Kiva. Kiva has helped almost 2 million students and entrepreneurs in developing countries to get access to small loans via the lending based crowdfunding model. These loans do need to be repaid within a reasonable period of time.

The Equity Crowdfunding Model

Under the equity crowdfunding model investors are purchasing an ownership interest (equity) in the business. This means the business is actually selling stock to raise startup capital.

In 2012 Congress passed the JOBS Act to make it easier for startup businesses to raise money via equity crowdfunding. It has taken some time for the SEC to fill in the gaps and issue the regulations under this new law. These regulations will be effective in May of 2016. By the end of May 2016, we expect to see more and more startups selling securities to raise money under this equity crowdfunding model.

Since this is such a new field we do not wish to link to or endorse any new site using the equity crowdfunding model. But rest assured that there will be dozens popping up in the coming months and years.

James H. (Jim) Gulseth was born and attended high school in Devils Lake, North Dakota and graduated with an A.B. degree from the University of California at Berkeley. He earned his JD degree at the University of California Hastings School of Law in San Francisco. He is a member of the Corporations, Business Transactions, Securities and Tax and Intellectual Property Sections of the State Bar of California and is a member of the State Bar of California, the Alameda County Bar Association, and a member and past President of the Eastern Alameda County Bar Association.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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