How to analyze a crowdfunding project?
Crowdfunding has become a popular form of investing. It can be very rewarding, not only from a financial point of view, but also because of the excitement you get from supporting new projects and ventures, especially ones you really like and believe in.
That said, it’s important to make sure that your money is in safe hands. You have probably heard the saying, “A fool and his money are soon parted.”
Even if your pledge is a donation or a pre-order, nobody wants their money to go to waste. And if your pledge is an investment (in the form of equity or a loan), you want to maximize your chances of success, not only to avoid losing your investment, but also to earn a solid return.
|Money raised last year through CF||Market growth||Number of CF campaigns p.a.|
|Approx. $ 12 billion||12 – 16 %||6 million|
Therefore, it is important that you have a comprehensive understanding of what you are investing in and do thorough due diligence on each project before making an investment decision. To help you do this, we have created a comprehensive guide on how to analyze a crowdfunding project.
This guide is divided into two parts:
- The first focuses on understanding the different asset classes and deal types in crowdfunding, as this has a major impact on potential investment returns,
- The second focuses on the key success factors of each project such as product, team, marketing, and other related aspects.
Here’s the full table of contents:
Different types of crowdfunding deals
Before diving into the analysis of a particular project, it’s important to understand the different types of crowdfunding as that has a big impact on the risks, rewards, and how investment returns can be realized.
In other words, there is a huge difference between a donation, a perk, a loan, or an equity stake in the company.
The main issue here is that sometimes the terms of the deal are not easily understood, and it’s important not to make assumptions about what kind of deal you are getting into or skirt the fine print.
It’s your job as an investor to take enough time and study the deal terms until you fully understand where you are investing your money and how you are going to get it back. Essentially, it’s imperative to know how you will exit the investment.
We know of five different types of crowdfunding based on how the investor is compensated. They are:
- a reward
- a donation
- an equity stake
- a loan
- a share in the sales generated
This last type is quite rare, but you may stumble upon such an offer every now and then.
Let’s take a closer look at each type of reward:
Crowdfunding as a support
Reward and donation-based crowdfunding types are not meant to be an actual investment, but either a monetary donation to a good cause you believe in, or a pre-order and support of a business by becoming an early customer.
Even if your pledge is not an investment, it is still wise to carefully analyze a project and make sure it has a great chance of success (or that it is not a scam). That said, due diligence can be a little easier since return on investment is not in play.
1. Donation-based crowdfunding
In donation-based crowdfunding, no compensation is expected. This type of project funding is philanthropic in nature. Most often, the formal type of transaction is either a donation or a gift.
In this case, you’ll just want to make sure that the project is not a scam, and that the money will actually benefit the end goal and not get lost in management overhead or some bureaucratic machine.
2. Reward-based crowdfunding
This was one of the first models of crowdfunding that offered backers the option of pre-ordering the products or access to attractive perks; or a combination of both.
This type of crowdfunding is mostly used for pre-selling products, which is also a great way for creators/entrepreneurs to get an assessment of an idea from the market. It is also a very tangible way to get feedback on whether or not potential customers are interested in the product.
Some popular perks of reward-based crowdfunding include:
- Discounts – special discounts on products or for a certain time, 2-for-1 deals, etc.
- Special lines of products – VIP collection, pre-released versions, premium samples, etc.
- Unique experiences – dinner with founders, office tours, a thank you call, etc.
- Special recognition – personal thank you notes, wall of fame, social media exposure, etc.
Crowdfunding as an investment & support
After their inception, donation and reward-based crowdfunding quickly evolved into a crowdfunding-as-investment model, the main reason being that it is quite difficult for new businesses to raise money.
Banks have no affinity for high-risk early ventures, and business angels and VC funds can have extremely demanding investment criteria.
With crowdfunding as an investment, you can make money in three different ways – by owning part of the business, lending money based on the agreed interest rate, or receiving a small revenue share when the business starts to make sales.
3. Equity-based crowdfunding
The basic idea of equity crowdfunding is that the investor receives a small share in the (new) company. There are different types of equity or equity-like investments (equity share, convertible bond, SAFE…), but that is a topic to be tackled in another article.
Equity crowdfunding is the most common alternative to business angels and venture capital investments, meaning it is a high-risk, high-reward game. Not many new ventures succeed, but those that do can earn excellent returns.
If you invest in equity-based crowdfunding, there are several ways you can get your money back:
- Initial Public Offering (IPO) – the company gets listed on the stock exchange.
- Secondary markets on crowdfunding sites – the company gets listed on a private marketplace.
- Private deal – you find another individual who’s willing to buy your share.
- Mergers & Acquisitions (M&A) – the company gets acquired or merged.
- Share buyback – entrepreneurs offer to buy back shares from crowdfunding investors.
- Dividends – you enjoy dividends distributed from the profits of the company.
Owning an equity is usually the core part of every good investment strategy.
4. Lending-based crowdfunding
With loan-based crowdfunding, you do not own any part of the business, but rather only fund part of a loan at an agreed-upon interest rate, and receive your principal back with interest if nothing goes wrong.
This type of crowdfunding is most popular for lower-risk projects, and is also very popular for real estate deals.
5. Sales-based crowdfunding
The last type of crowdfunding is based on how well the company increases its sales. You may be entitled to a small portion of the revenue the company makes, or you may receive a royalty on each new sale.
This is the rarest form of crowdfunding, but it is possible to find a few deals structured this way.
Different asset classes and industries
Now that we know how you can be compensated for your crowdfunding investments, the next important thing to understand is what type of asset class and industry you are investing in.
With more than 6 million projects raising funds each year, there is almost no asset class or industry that doesn’t utilize this funding structure. In addition to general crowdfunding platforms, you can also find specialized platforms for specific types of investments (real estate, healthcare, hemp, IT, video games, etc.).
Just as there is a big difference between investing in stocks, giving a loan, or placing a pre-order; there is also a big difference between participating in crowdfunding campaigns for startups, real estate, or crypto projects.
The best advice in this regard is to understand the asset class really well, as this will certainly give you an edge when it comes to choosing investments. The world of investing has become too complex to just invest anywhere and see what sticks. The best way to improve your chances of success is to study a chosen investment niche in detail.
The most popular asset classes in crowdfunding are:
1. Start-ups / Scaleups / SMEs
Start-ups are new ventures, usually based on an innovative idea. Most start-ups fail, but those that succeed can make large profits for their early investors.
There are many reasons why startups can fail; from poor management to a poor supply chain to bad timing or a lack of demand for the start-up’s product or service in the market. People who invest in startups through crowdfunding are usually also interested in buying their products, which means crowdfunding is also a great way for startups to test the market.
Scaleups and SMEs (small and medium enterprises), on the other hand, are separate from the riskiest startup phase. The organization is already established to some degree and has stable sales or high demand in the market, yet they need to raise additional money to accelerate their growth. The risks for investors are much lower, but valuations are much higher.
2. Real Estate
Real estate crowdfunding has changed financing in the real estate landscape, and investments that were once reserved for banks and wealthy individuals are now accessible to retail investors (the general public).
The risks associated with real estate investing mainly concern finding experienced developers and builders and developing a financial model that makes sense; i.e., raising enough capital and selling/renting the properties at high enough prices to generate the desired returns.
3. Distressed ventures
Most of the time, these are mature companies that have run into trouble due to sudden market shifts or poor management, but still have the possibility for a turnaround and continued growth.
A similar option lies in distressed real-estate projects, i.e., those properties in foreclosure or bankruptcy that can be acquired at a reduced price.
4. Crypto / Art / NFTs
Crypto has its own mechanisms of crowdfunding (ICO, IDOs…), yet you can find crypto and blockchain projects on general crowdfunding platforms, or on specialized crowdfunding platforms for this type of asset class. Similarly, you can find platforms focused on shared investments in art, NFTs, etc.
Last but not least, we must not forget about the projects that most often seek a donation or a pre-order:
5. Social and creative projects
This term includes all kinds of projects, from launching new books and movies to charity projects, and so on. These types of projects are not meant as an investment, but rather as a way to buy a product that you like, join a good cause, or support an artist that you admire.
How much you are willing to risk?
Now you should be able to easily categorize the crowdfunding project you are considering. Now comes the question how much are you willing to risk?
Equity is considered a riskier investment, but comes with no cap on potential returns. Loans, on the other hand, have a fixed interest rate, which is the upper limit on the return on your investment.
Startups are considered the riskiest investment. In the later stages, when the company finds a product-market fit, the risks are lower, but so are the returns. At the other end of the spectrum, real estate is considered a safer investment when the market is stable and experienced investors are behind the project.
You should always match the investment risks to your risk preferences and investment strategy.
Now that we have come to the end of the first part of this guide, below are the main questions to ask yourself before pledging funds to a crowdfunding campaign:
- Do you understand the deal type – is it equity, debt, or some other kind of a deal?
- Do you understand the terms of the deal – the number of shares you’re getting, the interest rates, and your rights and limitations as a crowd investor?
- Will there be a nominee from a crowdfunding platform?
- Do you know how will get your money back – loan repayment, dividends, acquisition, IPO, liquidation of a company etc.?
- Is there any other “small print” you should go through and understand?
- Do you understand the risks associated with the asset class / how risky the investment is, and how it will impact your financial status in the case that it fails?
Not to discourage you, but these are only the basic questions you should ask before committing funds to a project; as an investor, it’s extremely beneficial to also be able to understand the legal and financial structure of the deal in detail.
To do so, you should be able to answer the following questions:
- Are the team members majority shareholders of the company?
- How many classes of shares does the company have? Will all investors get the same class of shares?
- Is the valuation reasonable when compared with businesses in a similar growth stage and industry?
- Is the company a single entity? if not, will the investment be in the parent/holding company?
- Does the entity own all the intellectual property rights?
- Will there be any debt repaid with the money raised from crowdfunding?
- Are the team members dedicated full time to realizing the pitched business idea?
- Are all the necessary regulatory approvals in place?
If you do not have answers to the above questions but want to gain more knowledge, we promise to prepare a separate blog post on financial and legal due diligence for a CF campaign.
You should decide how much you are willing to risk per investment based on the answers to all of the above questions. Besides knowing what you are investing in, risk management is one of the most important aspects of being a successful investor, and it isn’t advantageous to lose too much of your asset allocation to the riskiest deals.
The due diligence of a crowdfunding project
Now that you know the different types of crowdfunding deals and the risks associated with them, it’s time to take it a step further and focus on how to analyze a particular crowdfunding project.
Most commonly, analyzing a company for a potential investment is referred to as due diligence. Due diligence is the process of verifying, investigating, or even auditing a potential investment opportunity to verify all relevant facts.
The objective of due diligence is to confirm the accuracy of the information provided. As an investor in crowdfunding projects, you should always take the time to perform thorough due diligence.
This is the only way you can lower the risk on already risky investments (besides diversifying your portfolio).So, let us take a look at how to perform due diligence on a crowdfunding project like a pro.
Before taking the time and energy to analyze a specific project, you should first look for obvious signs of a trustworthy project. The following are good signs to look for:
- The project is on a well-known and trusted crowdfunding platform (like Equito)
- There are already supporters backing the project (and they are listed)
- The project is managed by a team with a good track record, preferably directly from the industry
- The promotional materials are professionally produced, including the promo video
- All the information about the business is available, there’s no sign of anything being hidden
- At least the basic financial information is available (loans, projections …)
- There’s a factual prototype available, or the first series of products (a big plus)
- The story doesn’t sound too good to be true
If there are no red flags and you really like a project, it’s time to start performing due diligence. For good due diligence, you need to invest about 4 to 24 hours – sometimes even more. You can browse first-hand experiences and opinions from investors performing professional due diligence on our forum.
The process of gathering the key data
The first step in any analysis is to gather information, and due diligence for crowdfunding is no exception. When analyzing a crowdfunding project, you need to look for information from two sources:
- Information provided on the crowdfunding site
- Other information you can find on the internet
The most popular crowdfunding platforms usually have quite high requirements for investment documents and promotional materials. The project must pass the crowdfunding platform’s internal due diligence, but that does not mean you should not do your own.
The scope of information about a particular project on a crowdfunding platform usually consists of the following materials (although we’re very aware that information might often be too scarce):
- Basic information
- The business idea
- Key highlights / Accomplishments to date
- Promotional video
- Investment summary / Deal type / Direct investment or nominee
- Additional investment perks
- Investment documents
- Pitch deck
- Loan disclosure
- Financials / valuation rationale (rarely available)
- Detailed business plan (rarely available)
- Discussions / FAQ
The quality of the documents produced is already an important sign that shows the quality of the team. In addition, you should also look for other sources about the industry, product, or team that can be found on the internet.
You should check for the following information in particular:
- Interviews with founders, their LinkedIn profiles, social endorsements, references, etc.
- Competing crowdfunding projects and any other competitors in the field
- Any industry information; such as trends, growth, specific challenges, etc.
- Patent databases, making sure there are no intellectual property infringements
- Any other relevant information connected to the project
We recommend that you open a new folder on your computer and collect all the available documents in one place. Then, go through the documents conscientiously and evaluate the company’s strengths, weaknesses, opportunities, and threats.
This process is known as a SWOT analysis and is one of the bast ways to promptly analyze a new business.
Analyzing the key success factors of a project
There are several factors that are critical to the success of any crowdfunding campaign. Projects that show weaknesses in any of these aspects have a lower chance of success. There are always exceptions, but you don’t want to bet solely on entrepreneurial luck.
There’s also a slight difference between analyzing real estate and startups/scaleups, or crowdfunding projects, but the general direction is pretty similar – look for a team with a track record and a unique idea or opportunity with market traction.
Below, we will focus on analyzing crowdfunding opportunities for startups/scaleups as this can be a bit more complex than analyzing a real estate project.
When analyzing an equity crowdfunding project in a startup, scaleup, or SME; focus your energy on analyzing the following aspects:
- The team
- The business idea
- Technology, production, and supply chain
- Business development, marketing, and sales
- Whether the project exciting for you
Now let’s do a deep dive into each of these aspects and what to look for when assessing an equity crowdfunding project in a new venture.
1. The team
Everything begins and ends with the team. The team is also the most difficult part of a project to analyze. You should pay special attention to good references, energy, and the quality of promotional videos.
Ask yourself whether you are convinced. You must somehow feel the energy and entrepreneurial skills of the team. Pay attention to the following points:
A clear and ambitious vision
Does the team have a strong vision and mission, and are they in business for reasons other than solely making money? The vision should be reflected in their enthusiasm and passion for what they do.
Their vision and mission should also provide a strong answer to the question “Why are they undertaking this project?” and provide an emotional drive to overcome many obstacles on the entrepreneurial path.
The more business experience and references the team members have, the better. It is also beneficial if the team proposing the project has worked together on other successful projects. Founders getting into a quarrel is one of the most frequent reasons why ventures fail.
Venture capitalists love to invest in serial entrepreneurs because it is one of the best predictors of success. That does not mean you should not invest in completely new entrepreneurs, which might be riskier. You should also make sure the team doesn’t only look good on paper, but that they have actual references and experiences.
Technological and business knowledge
The team should have the appropriate technical knowledge to implement the proposed idea in the crowdfunding campaign and be aware of the technical risks. It is a great advantage if the team has previous experience in prototyping, product and service development, and experience in the industry in which their idea is located.
On the other hand, the team should have sufficient business knowledge to cover the main business functions, i.e., supply chain, production, marketing, sales, finance, etc.
Team members should not only be technical experts, but also have someone with business experience or aspirations on the team. Teams with a good balance of business and technical experts have the best chance of success.
In real estate crowdfunding, it is equally important that teams have experience with real estate development and that they have a reputable construction team on board.
2. The business idea
We put the team first, even though we know it’s probably the idea and your desire to participate in a crowdfunding campaign that caught your attention. There is no better feeling than investing in products or services that you feel are missing on the market, or that you are excited about.
On the other hand, there are more than 6 million crowdfunding campaigns annually, and many of them unsuccessful. The fact is that most ideas fail, so, your personal excitement is enough. You should also use your analytical skills to evaluate the idea from an objective point of view.
This is what you should be looking for when analyzing the business idea:
The need / problem on the market
There should be a specific need, issue, or trend that the business idea is addressing. If there is no need; if there is no problem to solve that people are willing to pay for, the chances of success are slim.
Ideas can be divided into a simple concept based on medicine:
- antibiotics (a must have)
- aspirin (good to have)
- vitamins (luxury)
Make sure you know which category the business idea falls into and why customers are willing to open their wallets. If there are no customers, there’s no business.
Every product or service should have a clear differentiator, meaning it solves the need on the market in a different way than all others. The differentiator provides a clear distinction in the market between the company and the competition.
It should be clear why customers should choose the company’s product rather than the competitors’, and the differentiator should be the main reason.
The market / buyers / ideal customer
The company should have a clear picture of which market segment(s) it is targeting and who the ideal buyers (personas) are for each segment. Initially, it is advisable for a new company to focus on one segment and then expand to new ones.
It is also important that the market is large enough and growing, because that is the basis for the rapid growth of any business. Small markets cause nothing but headaches.
The most common mistake made by entrepreneurial teams is to claim that there is no competition. True entrepreneurs are well aware of their direct, indirect, and potential competition.
Competition always exists, therefore, it is much more important for the team to have a thorough plan on how to defend the competitive advantage in the marketplace than being convinced that there are no competitors.
And if there really is no competition (in extremely rare cases), it is very doubtful that a sufficiently large market exists at all.
Timing is one of the most important factors in the success of a new venture. If the company is too quick to market with a new idea, the product will be bought only by early enthusiasts, who are usually too few to build a serious business on.
There is a big difference between serving a small group of enthusiasts and serving a mass market. This trap is called “crossing the chasm” in venture businesses.
On the other hand, if the company is late to the show, it will collect crumbs in the market. Therefore, an important question to ask when evaluating the market is whether the timing is right, or why now is the perfect time for this idea.
3. Technology, production, and supply chain
When dealing with products in crowdfunding, even when the idea and team are in place supply chain and production issues can arise and cause projects to fail.
Underestimating the challenge of building a new production line is probably one of the most common mistakes crowdfunding entrepreneurs make. It’s a disaster for the venture (and everybody else) – having the idea, team, and funds, but then not being able to fulfil the orders.
Therefore, you should evaluate the following aspects in this regard:
An important thing to consider is the underlying technology behind a product or service. Even if the project is not high-tech, today almost every business leans on technology in some way.
When evaluating an idea from a technological perspective, it’s important for the team to have a working prototype, good user experience and the right technology stack. A must is also to be organized in a lean way, being able to produce new iterations in fast sprint cycles.
Production line and process
The team should have a clear idea of how they want to set up the production process. There is a big difference between building a few prototypes and organizing a whole new production line. It’s a great advantage if they have experience in this area, or at least experts on the team who can help them set up production.
One of the biggest problems businesses face today (post-COVID –19) is the organization of the supply chain and the procurement of materials. The team should carefully review and select its suppliers both domestically and internationally.
Suppliers should be selected based on quality and price, and, of course, the necessary materials should be available in the required quantity and at an acceptable price. It’s beneficial if there are no materials in the product that have supply issues, or that have highly-volatile prices.
When it comes to intellectual property, several issues come into play. The first is to ensure that the team does not infringe any existing patents, trademarks, or other intellectual property, as this carries significant legal and financial risks if it occurs.
The second question is whether the idea should be patented. If the answer is yes, there should be legal documents claiming the protected intellectual property. As we know, an idea cannot be patented once it is presented to the public (e.g., with a crowdfunding campaign).
It’s also considered a foundation for the business to have their trademark protected.
Reclamations and complaints
The team should have a clear overview of how they will handle complaints and product reclamation. With new products and first production runs, there are usually some kind of challenges with quality and potential malfunctions.
These types of issues should not be underestimated. Inadequate production monitoring, lack of quality control, and too many complaints which are not calculated in the financial plan can be fatal to the business.
Long-term product portfolio
Many crowdfunding campaigns have the problem of building a business around a single product and then finding out that it is not sufficient. Therefore, it is beneficial for the team to have an idea of what new products should be added to the production line.
Production and supply chain issues are present with product companies. Service companies have other challenges, such as how to organize processes to scale the business (which can be extremely difficult), provide a high quality of service, and attract a critical mass of talented people.
Besides this, they also need a business model that enables them to grow quickly.
4. Business development, marketing, and sales
The rule for startups is that it is easier to make a product than to sell it, so, the team should have a solid marketing and sales plan knowing that the products will not sell themselves, no matter how impressive they are.
The company should have a good marketing plan that includes a pricing, distribution, and communication strategy – employing online and offline media. The business should have engaging branding and marketing materials, and a good social media presence.
If sales are made through digital channels, the company should also have internal digital marketing competencies.
As the saying goes, sales cures almost all business challenges. Sales is probably the most important part of any venture, as without revenue, there is no business. At least one member of the team should have very concrete sales experience.
A sales-oriented approach to business should be clearly seen in the crowdfunding campaign’s promotional materials.
5. The financial side of the business
Finally, we come to the financial side of the business. In startup projects, it is difficult to make solid projections because there is no history of business operations, meaning all numbers are just assumptions. In the scaleup and mature phases, things are different and more realistic projections can be provided.
In any case, you should make sure that the valuations are solid, that the financial plan is not too optimistic, and that your contribution will help the business grow.
Existing loans are usually disclosed on crowdfunding platforms with the information about the project. This is important, as the company should not have too much debt. The funds raised should be used to grow the business, not to repay existing loans.
Business model and pricing strategy
The team should have a clearly defined business and revenue model, and be able to justify why it has chosen a particular business model. The chosen business model should enable the company to grow fast enough.
The company’s pricing strategy and discount policy should also be clearly designed. The gross margin must be large enough to ensure the company’s long-term profitability.
The team should have a realistic valuation of the company. You should compare the valuation of the business to a similar one (phase, industry). An important aspect of successful investing is that you do not overpay for the shares you’re buying.
The team should present you, the investor, with possible exit strategies. If there is no clear exit strategy, you may be stuck in the company and unable to sell your shares.
Crowdfunding investments are not considered liquid investments. Therefore, even if there is a clear exit strategy, you need to be patient and give the team a few years to grow and build a successful business.
This leads us to the last important question:
Final question – Does the crowdfunding project excite you?
The last item on the checklist is whether the projects excites you. Sometimes it makes perfect sense to invest just because of a good ROI; and sometimes you might be skeptical of the business model, but like the idea so much you decide to support it.
But when you can combine both – magic can happen.