What Is Crowdfunding?

What is crowdfunding?

Crowdfunding is a non-bank financing option in which startups accept small donations from many people to receive a much-needed cash boost to get their ventures off the ground. Entrepreneurs typically launch crowdfunding campaigns via internet platforms; they set time frames for raising money and disclose specific monetary goals.

Crowdfunding contributors can include friends, family members, investment groups, personal investors, and those who simply are interested in your venture. The goal is to attract as many potential investors as possible. 

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Crowdfunding types

You can raise money via several crowdfunding models:

• Donation-based crowdfunding: With donation-based crowdfunding, people donate money and expect nothing in return.
• Debt-based crowdfunding: Debt-based crowdfunding donations are a form of peer-to-peer (P2P) lending. In this model, you must repay your backers with interest by a specific deadline.
• Rewards-based crowdfunding: In rewards-based crowdfunding, donors receive something in return for their donations. Rewards typically vary by donation size to incentivize higher contributions. For example, donors may receive a T-shirt or a free product or service.
• Equity-based crowdfunding: Equity-based crowdfunding allows small businesses and startups to give away a portion of their business in exchange for funding. These donations are a type of investment; participants receive shares in the business based on how much money they contribute.

Crowdfunding rules

Most crowdfunding platforms have specific rules. Reading your crowdfunding platform’s rules carefully before launching a campaign is crucial. For example, Kickstarter doesn’t allow equity crowdfunding and has a list of prohibited items.

If you ignore the rules and jump into your crowdfunding campaign, the likelihood of success plummets. Do your due diligence and find the best crowdfunding platform for your needs.

Crowdfunding outcomes

When your crowdfunding campaign closes, one of the following happens:

1. You don’t reach your goal. If the campaign doesn’t reach its target amount, funds are typically returned to the backers. Some crowdfunding websites allow you to keep the money you raised, but you may have to pay a fee.
2. Your campaign is successful. If the campaign is successful, you receive the total amount of money you raised minus processing fees. For example, Kickstarter charges a 5 percent fee for hosting the fundraiser and a percentage-based fee for payment processing. These payments are incurred only when your project succeeds. 

Equity crowdfunding campaigns work a little differently. When they conclude, you must follow through with your specific obligations to the backers. 

Crowdfunding upsides and challenges

Crowdfunding is a viable option if you’re starting a business or embarking on a project. However, it isn’t always the best funding solution. “Crowdfunding works for all kinds of companies at all different stages, but the companies that have the most successful campaigns tend to have the largest and most engaged communities behind them – usually of customers or users or other supporters of their mission,” explained Kendrick Nguyen, CEO and co-founder of crowdfunding platform Republic.

Consider the following upsides and challenges of crowdfunding.

Crowdfunding upsides

Crowdfunding brings the following benefits to startups and businesses launching projects and ventures: 

• Crowdfunding acts as free marketing. Crowdfunding often acts as a type of marketing. To receive the financial support you seek, you must pitch your business idea to potential investors. As you market your brand, you’ll likely gain followers and a customer base that will help your business grow. Investors fund businesses they think will be profitable, and many of your investors could become loyal customers. 
• Crowdfunding diversifies funding sources. When you use crowdfunding to finance your business, you rely on multiple investors and funding sources. Diverse funding sources can protect you if some investors pull out of the deal. They also offer more potential for scaling your business. For example, some investors may evolve with your business and continue to support you as your business grows.
• Crowdfunding is an accessible funding source. Crowdfunding is accessible. Unlike getting a business loan, anyone who wants to start a business in any industry can pursue crowdfunding as a financing option. It’s a private funding source that won’t be impacted by a poor credit score or minimal business experience. All you need is a well-thought-out business idea to attract supporters.

Additionally, crowdfunding benefits investors and donors in the following ways: 

• Crowdfunding is low risk. Investors appreciate a low-risk venture, and crowdfunding offers just that. Investors don’t have to worry about economic or stock market factors impacting their investment.
• Crowdfunding is easy. It’s easy to invest in a crowdfunding campaign. Investors can put money into a project or company through a straightforward online process.
• Crowdfunding offers many options. Equity crowdfunding allows investors to fund multiple campaigns, helping them expand their financial opportunities and diversify their portfolios.

Crowdfunding challenges

Successful crowdfunding requires substantial effort. You must present a project that discerning backers find valuable, so strategic marketing is crucial. 

According to Ryan Sim, former co-founder and managing director of We The People – a company that sells only crowdfunded products – crowdfunding presents extensive challenges. While each venture will have unique obstacles to overcome, most crowdfunding campaigns will face the following issues: 

• Crowdfunding requires a high-level marketing strategy. For crowdfunding to succeed, you must develop and implement a cost-effective marketing strategy before, during and after the campaign.
• Crowdfunding requires the right messaging. Your crowdfunding efforts can be derailed if you don’t craft a message that resonates with potential backers. Driving interest in a product or service can be exceptionally challenging.
• Crowdfunding videos must spur excitement. Many successful crowdfunding campaigns include videos that explain the product and its benefits. Producing a compelling video can be expensive and time-consuming. Plus, you must ensure your vision translates to something that resonates with backers.
• Crowdfunding rewards must be compelling. Crowdfunding rewards must be compelling and resonate with donors. It can be challenging to create and plan an effective and cost-efficient rewards program that strategically maximizes the campaign’s ROI.

Equity crowdfunding has even more unique challenges. According to Connor Young, founder and CEO of Ample Foods, equity crowdfunding requires more emphasis on educating potential donors who aren’t angel investors and don’t necessarily have any investment background.

“We’re all so used to buying products online, so investing in a regular crowdfunding campaign is quite easy,” Young explained. “You just say, ‘Oh, OK. I’m basically prepurchasing a product that doesn’t exist yet, and I’m going to get it in six to 12 months.'” However, businesses must tread carefully when offering equity in their ventures, because these donors will become stakeholders in the business.

The best crowdfunding platforms

Many online crowdfunding platforms can help you fund your venture. Here’s a look at four of the top crowdfunding sites available:

Kickstarter

Kickstarter is a rewards-based donation platform helping companies raise money since 2009. It has been used to raise over $7 billion for over 250,000 projects. Part of what makes Kickstarter so successful is how simple the site is to use. You set a monetary goal and time frame and tell your campaign’s story. You then share your project with the community in hopes of finding backers.

GoFundMe

GoFundMe is a donation-based crowdfunding company. While it’s known for charitable initiatives, businesses can also use the platform. GoFundMe is an excellent option for nonprofit organizations and businesses with service-based initiatives. Around 50 percent of GoFundMe campaigns are considered successful.

LendingClub

As a P2P lending platform, LendingClub is a debt-based crowdfunding site. It offers up to $40,000 in personal loans and up to $500,000 in small business financing. Each loan term is three or five years. To qualify, your company needs to have been in operation for at least a year, the applicant must own at least 20 percent of the business, and the business must have an annual sales revenue of $50,000.

Indiegogo

Indiegogo is a reward-based platform that offers two kinds of funding. Fixed funding allows you to set a specific monetary goal; if you don’t reach your target, all funds are returned to donors. Flexible funding is when you’re looking for any monetary support, all of which you can keep even if you don’t hit your goal.

Tips for crowdfunding success

There’s no one-size-fits-all approach to crowdfunding, but there are five key places to start on your road to crowdfunding success. Consider the following business crowdfunding tips. 

1. Communicate with backers.

Young stressed the importance of being transparent with backers throughout the process, even after the campaign ends. For example, delays are expected in product launches, so reacting with honesty and transparency is crucial.

“A lot of it is simply ‘do you have good communication with your backers, even when things go wrong?'” Young said.

As your campaign closes, update your community. Explain where to reach you next and whether you plan on shifting focus to preorders through your website.

2. Share relevant and engaging marketing materials.

A good batch of marketing materials, including videos, will help your campaign stand out.

“It’s about making an emotional connection with someone just as much as it is about actually explaining what the product is,” Young shared. “One of the really big reasons why someone invested in Ample in the first place was simply because they thought that I was an authentic guy and that I really seemed to care and be passionate about it.”

With new crowdfunding campaigns launching daily, making your campaign stand out from the others is essential. Creating a solid marketing plan and spreading the campaign through your network are the best ways of gaining recognition.

3. Prepare for the campaign.

For the best crowdfunding results, prepare for the campaign before launching it. Tell your family and friends you’re launching your campaign. Be active on your personal and company social media accounts before the launch. Give potential backers every chance to find you.

Taking a few extra weeks to develop a plan and build excitement around the campaign can help you hit your crowdfunding goal.

4. Tell a story.

Though you want to remain professional when seeking crowdfunding, you also want to appeal to your potential investors’ emotions. Telling a story and personalizing your brand are great ways to do this. 

For example, share the following information: 

• How long have you wanted to start your business? 
• What makes you the right person to launch this company? 
• What ties do you have to the industry? 

Truly showcase your personality and passion for the project as you tell your story and share your dream.

5. Specify what you will do with the money.

Most donors want to know exactly where their money is going. When asking for funding, be specific about your plan. Will you use the funding for startup costs like an office space or the necessary technology? Maybe you’ll put the money toward marketing and advertising. Whatever the case, be transparent so your donors know they can trust you.

Examples of successful crowdfunding campaigns

Many projects with excellent ideas end up failing. In contrast, others with simple premises flourish beyond all expectations. Crowdfunding projects tend to follow a viral growth method and can be unpredictable without proper marketing.

Here are two examples of successful crowdfunding campaigns:

• RadioPublic: “One of my favorite investment campaigns on [Republic] to date was RadioPublic,” Nguyen recalled. “They’re kind of like SoundCloud for podcasts and have investors like The New York Times, the parent company of WordPress and the Bose Corporation. They raised just under $150,000 from some of their most passionate users and listeners. To me, their trajectory is similar to Gimlet Media’s – they ran a $200,000 equity crowdfunding campaign in 2014 and were just acquired by Spotify this month.”
• Peak Design: Another company that ran a successful campaign is Peak Design, which set a goal to raise $500,000 on Kickstarter for its Travel Tripod product. The campaign lasted 56 days and had 27,168 backers, raising $12.1 million.

Get started with crowdfunding

Crowdfunding makes small business funding accessible to all. If you’ve decided crowdfunding is the right option for your startup, research various platforms to ensure you work with the right crowdfunding site. Then, prepare your pitch and content, set a fundraising goal and plan your execution so you can launch your campaign. Potential donors and investors are right at your fingertips.

Sammi Caramela contributed to this article. Source interviews were conducted for a previous version of this article.