How Does Crowdfunding Work?
Crowdfunding combines the concepts of crowdsourcing and microfinancing, bringing together various individuals who commit small amounts of money to projects and entities they want to support. This is often done through websites that make it easy for entities to find potential funders. Funders could expect something in return for their contributions—such as equity, products, or services—or they may donate the funds. The people who fund crowdfunding projects and entities may do so without expecting anything in return—they’re donations to a cause they support. Others fund projects in exchange for products, services, or equity.
Example of Crowdfunding
One common example of crowdfunding is a creative project a musician you like may use crowdfunding to produce their next album. They make a Kickstarter page for the new album, outlining the basic ideas they have for it. You (along with other fans) contribute $10 to the project. In return, you will receive a digital copy of the album when it’s done. Oftentimes crowdfunding efforts often involve tiered rewards. A $10 donation may earn you a digital copy of the album, whereas a $20 donation gets a vinyl album shipped to your house.
Types of Crowdfunding
Reward-Based Crowdfunding
Perhaps the most popular crowdfunding method comes in the form of rewards-based sites like Kickstarter and Indiegogo. With reward-based crowdfunding, people can pledge money to creative projects, a novel piece of technology, or any other product or service.
Peer-to-Peer Lending
Ever loan small amounts of money to a friend or relative? Platforms like Lending Club and Prosper apply that same concept to crowdfunding. This enables borrowers to get access to funds outside of traditional banking channels. People willing to take a little risk to lend money to other individuals can create whole loan portfolios at the click of a button.
Donation-Based Crowdfunding
Crowdfunding sites are also used by nonprofits seeking donations. Sites like GoFundMe give organizations a free platform to raise funds for their causes. Instead of taking a cut of their donations, GoFundMe asks contributors directly for a donation to help keep the site running.
Equity Crowdfunding
The smallest slice of the crowdfunding pie, equity crowdfunding nonetheless has the potential to change the way individuals invest their money. Equity crowdfunding enables investors to make real investments in private companies. Sites like AngelList, CircleUp, and OurCrowd offer their own take on equity crowdfunding. Equity crowdfunding is less regulated than other methods of equity financing. While most businesses need to go through an SEC registration process to issue equity shares, companies can issue up to $1.07 million in securities through crowdfunding methods without going through that process. There are limits on how much investors can invest through equity crowdfunding. These limits depend on the investor’s income bracket and net worth. If either your net worth or annual income falls below $124,000 you can invest up to $2,500 or 5% of your annual income (whichever is greater) through equity crowdfunding every year. If your annual income or net worth exceeds $124,000, you can invest 10% of the income or net worth (whichever is greater) up to a maximum of $124,000.
Real Estate Crowdfunding
Real estate crowdfunding sites combine the concepts of crowdfunding and real estate investment trusts. Examples of these sites include Fundrise, RealtyMogul, and CrowdStreet. Contributors kick in small amounts in exchange for equity in real estate (often commercial real estate).
title: “What Is Crowdfunding " ShowToc: true date: “2022-12-18” author: “Linda Brown”
There are three distinct types of crowdfunding that entrepreneurs can use to raise funds for their business:
Reward crowdfunding: This type of crowdfunding offers backers of your campaign rewards, such as exclusive experiences or an early version of your product or service.Debt crowdfunding: This method allows lenders to loan a portion of the funds and earn interest upon the debt repayment. Equity crowdfunding: This method gives supporters investment opportunities in exchange for equity or potential future return.
How Crowdfunding Works
Let’s say you’re an entrepreneur who wants to go to market with an innovative product, and you decide to take the crowdfunding route to finance it. You can choose a popular platform—such as Kickstarter or Indiegogo—and follow the steps laid out by the specific platform to launch your campaign. To promote your crowdfunding campaign, you should implement key strategies such as social media outreach on your profiles and pages, email marketing with special offers, buying targeted Facebook ads, and creating a landing page for the product itself.
Examples of Crowdfunding
Crowdfunding can be a viable way of raising capital for entrepreneurs at any stage of their development. Side hustlers, solopreneurs, storefront business owners, and even tech startups have relied on crowdfunding. Here are some notable examples of businesses that launched as a result of crowdfunding:
In 2016, smartwatch brand Pebble raised over $20 million in its Kickstarter campaign. Rival Fitbit quickly acquired Pebble that same year, but the latter’s ability to launch such a successful campaign is noteworthy.Avid book reader Noelle Santos wanted to open a bookstore and wine bar in the Bronx. Santos launched a campaign on Indiegogo and raised over $150,000. She opened her bookstore, dubbed the Lit. Bar, in 2019.The makers behind Fidget Cube, a product to help people remain focused while working, at school, or even at home, raised nearly $6.5 million on Kickstarter.
Pros and Cons of Crowdfunding
Pros of Crowdfunding Explained
Low Financial Risk
Crowdfunding provides entrepreneurs with an opportunity to raise capital without taking on considerable debt or using personal finances for inventory, materials, or development. A successful crowdfunding campaign means that you will have raised enough funds to launch or grow your business venture.
You Keep Your Equity
You will have to share rewards with your contributors if you reach your funding goal in a crowdfunding campaign. However, you will not have to give up any equity or lose control of your business.
Enhanced Visibility
Launching a crowdfunding campaign can be a strategic way to enhance your business’s visibility—even if you’ve yet to reach your funding goals. By developing a marketing plan around a campaign, complete with social and email outreach, an entrepreneur can develop a vital relationship with prospective clients and customers. And if a campaign generates buzz or goes viral, that can be a win-win for a small business owner who wants to raise capital—or, at the very least, create lasting brand awareness.
Cons of Crowdfunding Explained
Limited Time and Large Investment
Crowdfunding can help build awareness and publicity for your business, but it also comes with the pressure to deliver in a short time and may require a sizable investment in marketing (such as ads, promotional videos, etc.) in order to run an effective campaign.
Your Campaign May Be Unsuccessful
According to The Crowdfunding Center, the average success rate of crowdfunding campaigns— which means fully reaching funding goals—is only 23%. An unsuccessful campaign can also lead to bad press, harm to brand reputation, and wasted time and investments. With the popularity of this practice and the multitude of crowdfunding platforms, it has become increasingly difficult of late to get traction. High-budget rewards and digital marketing campaigns are performed to support crowdfunding campaigns with no guaranteed results.
Your Idea Could Be Stolen
For some entrepreneurs, crowdfunding can be a viable way to gain funding for an invention. Unfortunately, it can also create the potential for your idea to be mimicked by a company with financial backing to make your dream product their own profitable reality. Even with intellectual property, however, another business can still replicate a product, which can make entrepreneurs reconsider the value of crowdfunding.
