Equity-Based and Debt-Based Crowdfunding
In equity-based crowdfunding the contributors are identified as investors. They don't just contribute to the cause of the business; they aim to improve the company's growth, and they earn a specific percentage ownership of the business. They become part owners. Compared to the types mentioned earlier, the investors contribute a large amount of money and share in the profit. The entrepreneurs are primarily in the driving seat. They regulate the amount an investor can put in and the percentage equity they get. In this business the risk is high, because all investors will lose their investment should the business fail.
Some of the dangers: the venture needs ample time to develop and make profits. Investors have to sell their shares to earn anything; otherwise they wait for years for a gradual return. The invested capital is locked up in the business's coffers without yielding anything. It might not pose a problem for wealthier investors, who have other sources of liquid capital. Also, the investors' interests are not necessarily protected when the company decides to raise more capital. More shareholders come in, the percentage equity of the initial investors decreases, and the shares can get diluted. Protection against this event must be added to the policy.
Businesses can raise funds in two ways. Tier 1 sets a 12-month request for a business that wants to raise a large capital; the company has to register and provide details of the offering for review, with no prior audits and systematic report requirements. Tier 2 lets entrepreneurs raise capital up to $50 million within 12 months, with detailed offering circulars, semiannual and annual reports, and internal and external audits. Non-accredited investors can only invest about 10% of their net income or net worth.
Debt-based crowdfunding is widely regarded as a peer-to-peer loan-based lending system. It was made available for entrepreneurs who have difficulties securing bank loans. The investors expect a return on their loan as repayment at certain intervals and agreed interest rates. It suits those who do not want to lose equity in their businesses but are sure of the business prospects to repay the loan. The primary perk, as opposed to regular bank loans, is that it offers a low interest rate, and the fundraisers determine the terms of the loans. The risk is the fundraiser's inability to repay, in which case the investors lose their investments.