What is Crowdfunding?

Crowdfunding, which is also known as crowd financing or crowdsourcing, is a new finance-sourcing mechanism in which members of a network (usually an Internet network) pool their money to finance social or commercial ventures initiated by other people or companies. These ventures can be anything from making a movie to helping disaster victims to creating open source software to online journalism to start-up funding to making music.

Crowdsourcing finance has been made possible because of the social structure of the Internet. Companies like Zopa.com, Kiva.com, Wokai.com Prosper.com and LendingClub.com are crowdfunders. These companies function like online banks by offering interest on deposits and charging interest on the money lent by them. Lenders earn 5%-10.5% per year while borrowers have to pay 6+% per year. The differential is pocketed by the finance company that enables crowdfunding.

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Crowdsourcing finance companies enable microcredit and typically perform the middleman’s role. They ensure that every borrower is safe by diligently checking his creditworthiness. They also analyze the borrower’s venture or cause and determine if he is a qualified borrower. In fact, these companies adopt the same safety measures that are adopted by banks. They also hedge their risks by lending small chunks of money so that even if a bad debt occurs, it does not impact their operations. Moreover, the lender can choose his preferred borrower and the crowdfinancing company allows him to price in a safety margin in the rates.

Every lender and investor in America is on the lookout for investment opportunities because the economy is down and the bank interest is measly. In such an environment, crowdsourcing companies came as a breath of fresh air by offering fair returns and erasing the fear of lending to subprime borrowers. These non-bank companies are gathering momentum and a day may come when these companies will be considered as completion by global banks.

The biggest advantage of crowdfunding companies is that they encourage entrepreneurship. Entrepreneurs, who cannot get funding from conventional finance companies can turn to crowdsourcing companies and get their seed capital. In this sense, these companies provide a leg-up to entrepreneurs, help generate employment and boost the economy. The biggest disadvantage of this mechanism is that intellectual capital is not protected. Entrepreneurs have to disclose their ideas on the website putting their creative thought process at risk of being copied without their venture even having taken off.

Another disadvantage of this mechanism is that soliciting investments from the public is covered by securities laws, and therefore, it is possible that such schemes may get drowned in litigation and penalties at some point in time. Plus, if many borrowers start defaulting, and if the crowdsourcing company gets into trouble, then genuine investors may be left in the lurch.

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Whatever their disadvantages may be, crowdfunding companies have succeeded in enabling microcredit using the power of ecommerce and Web 2.0. Today, crowd finance has become a global phenomenon and has rekindled hope in the hearts of many discouraged entrepreneurs. Social causes too have received help in the form of adequate funding to meet urgent needs. All said and done, crowdsourcing finance is here to stay and grow.

Peter

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