27 January 15 -

Crowdfunding vs investment: is there a difference or is it semantics?

The crowdfunding model is not disruptive anymore.  As its presence continues to grow and the concept of raising capital via community hits the mainstream, the very definition of crowdfunding is being lost in translation.

Are we starting to take the model too far? By ‘too far’, I mean this: are we broadening its definition so much that it changes the meaning and expectation of what constitutes crowdfunding?

These days there are multiple global crowdfunding platforms that remove the financial barrier to entry for products, events, concepts, all forms of art and much more. You could even suggest that the crowdfunding model has reached saturation point. People use crowdfunding to get their potato salad made or request Nickelback not to tour. They also use it to get far more useful projects such as this, this and this off the ground.

The clear delineation that once existed between crowdfunding and investment models is blurred. The terms are used interchangeably in some circumstances as I’ll explain below and this creates confusing and misaligned expectations. One example is the recent Zach Braff debacle. He crowdfunded a portion of his independent film but also gained financial backing from a film financier. The financier made a return on his investment, but the crowdfunders didn’t. Should they have been promised equity?

People use the ‘crowdfunding’ term somewhat haphazardly. It’s common to add it to a marketing spiel because it’s trendy and a buzzword, not because it’s an accurate representation of a business model.

Crowdfunding vs Investment: the Basics

So what is crowdfunding? Let’s define it within the context of this article. According to Wikipedia, crowdfunding is

“the practice of funding a project or venture by raising monetary contributions from a larger number of people, typically via the Internet”.

The project could be anything – a product, event, film, album, coffee machine, cardboard desk… you get the picture.

Crowdfunding carries with it an ideal or purpose. You are helping to fund a project or product because you believe in it – you believe in why it must be. You demonstrate your belief by parting with your cash to show your support of the project.

People who crowdfund are said to demonstrate several traits that motivate them to support the project or cause. These include: connecting with the project/event/product, connecting with the cause of it, a desire to help the project make money and a desire to support innovation.

Usually, contributing to a crowdfunded project doesn’t grant you equity in the project. You shouldn’t expect to receive a profit or for the project to be a success. In other words, you contribute cash at your own risk or in return for some kind of ‘reward’ – for example, merchandise, the actual product, personalised mementos– provided that the funding goal is met.

Kickstarter – one of the largest crowdfunding platforms in the world – defines crowdfunding in the same way as Wikipedia. Kickstarter openly states on its website: “Project creators keep 100% ownership of their work, and Kickstarter cannot be used to offer equity, financial returns, or to solicit loans”.

Other platforms such as Pozible and Indiegogo also include this type of provision. However, you’ll find it in their terms of service – a link in the footer of their website.

Let’s now look at the concept of investment. According to the Oxford Dictionary, investment, or ‘to invest’, means to “put money into financial schemes, shares, property or a commercial venture with the expectation of achieving a profit”. We commonly align investment with the stock market, property portfolios and business ventures.

Investment is purely transactional. After making an informed choice to invest, you part with your money and speculate a return. It’s a gamble.

What’s the difference between crowdfunding and investment?

The main difference is crowdfunding promises no financial return on the money you contribute to a project. Investment, on the other hand, comes with a certain level of expectation – in the form of a financial return.

Yeah, so?

Well, here’s my point. The concept of crowdfunding is being used interchangeably with investment by the media and some organisations. This is misleading. Let me show you why with an example.

Crowdfunding and the law.

Access to justice is of fundamental importance in our global society.

However, court battles are not an even playing field (as much as we’d like them to be). If one party has access to better or more expensive legal representation, this can sometimes mean the difference between winning and losing. It’s harsh, but it’s reality.

A number of organisations in the US have started offering an alternative pathway for large cases – crowdfunding litigation as a form of access to justice and investment. Their marketing spiel is that justice is not equal and that in the battle between David and Goliath, David needs financial help to triumph against Goliath.

LexShares is one of the newest players in this space. With its sleek website and abundance of information about how they’re “revolutionising access to the justice system” it openly claims to be levelling the playing field when it comes to connecting plaintiffs with capital.

As a funder (or investor), you can browse open cases and choose the ones in which you want to invest. They’re not small litigation matters – LexShares invests in big corporate matters (no criminal matters). It has a team of legal professionals who research and assess the likely performance of each case.

If the case is unsuccessful, you won’t get a return on your investment; however, if it is successful, you receive a portion of the proceeds from the lawsuit.

All press coverage about the company, and companies like it, describes LexShares as ‘part Kickstarter, part online brokerage’ or similar. In other words, the media describes organisations like LexShares as crowdfunding organisations. There are other organisations that have a similar model to LexShares who describe themselves as crowdfunding organisations without any media input.

So, what does this mean?

The media and organisations such as LexShares are pushing the boundaries of what it means to crowdfund.

Crowdfunding – in the currently defined sense of the term – is at odds with LexShares’ business model. Of course, if you were interpreting crowdfunding on a broad level and looking at crowdfunding as being any type of financial contribution from two or more people, then yes, it might fly. But that’s not currently the literal definition and it’s not the definition that people are accustomed to referring to.

At its core, LexShares is an investment platform. The investment type is litigation. And the major difference between crowdfunding and investment is that when you make an investment there is an expectation that you will earn a financial return (albeit a risk that you won’t).

According to current definitions, LexShares is not really a crowdfunding organisation in the sense that we understand it and quite possibly shouldn’t be described as one. LexShares, and organisations like it, are investment companies. Pure financial investment. Even their tagline is ‘investment-focused’ – “Earn a return from litigation finance”. Q.E.D.

It’s worth noting here that the confusion caused by using crowdfunding and investment terms interchangeably is largely due to the historical roots of crowdfunding. I’m not saying that the connotation of those terms may not change over time as this new funding model matures, but that at the moment using the terms interchangeable arguably leads to confusion among consumers. I am not in any way suggesting that LexShares is doing anything wrong, but simply making the point that there needs to be more thought given by those marketing to consumers to avoid causing confusion.

Think about this scenario for a minute…

What if someone is wronged in a civil suit and desperately wanted to crowdfund their legal expenses so that they could afford appropriate legal representation? Would you part with your cash and help support them financially?

It sounds beautiful and kind – in theory. But would you really do it?

Now, think about if you could receive a financial return for helping that person. Would that make you more likely to contribute?

Crowdfunding in the context of the justice system is just one example of why we need to be careful about the terminology we use. Don’t say something is ‘crowdfunded’ because it’s an on-trend buzz word. Or because you think the tenuous link will get you more search results. It won’t. You will only confuse people and in some cases frustrate them.

If you’re offering some form of financial return on a monetary contribution then your project uses an investment model, it’s not crowdfunded.

What happens next?

While using these terms interchangeably causes much confusion, it has sparked an evolution in a new business model – equity crowdfunding. It’s still unclear whether this model is a natural evolution borne from the blurred lines of crowdfunding and investment models or whether it’s based on market demand. Perhaps it’s a bit of a both.

In my next article I focus specifically on the rise of equity crowdfunding in the US and Australia.

I’m keen to continue the discussion around semantics. Do you see issues with using the terms of ‘crowdfunding’ and ‘investment’ interchangeably?