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What is crowdfunding and how does it work

What Is Crowdfunding and How Does It Work

It’s no longer uncommon to see people taking to platforms like Kickstarter and Indiegogo, or creating a fundraising website or dedicated business website to raise funding for a new venture. Sometimes, the funds are meant to launch a new product. Other times, the goal is to fundraise for a charity or even an adventurous trip.

Regardless of the reason for seeking funds, the trend of crowdfunding has grown and become accessible to anyone from your high-school friend on Facebook to budding entrepreneurs.

But, just what is crowdfunding and how do companies succeed in using it to raise money? There are many different elements that go into a successful crowdfunding campaign, and if you’re just getting started it’s best to learn the ins-and-outs before jumping straight in.

What is crowdfunding?

Crowdfunding is the practice of collecting money from multiple individuals or sources in order to finance a new project. Often, crowdfunders turn to social media to share their platform or idea with the purpose of inspiring others to contribute to the crowdfunding campaign.

What crowdfunding essentially does is eliminate the back-and-forth between entrepreneurs and investors. Instead of waiting for an opportunity to pitch their product idea to a team of investors, entrepreneurs can take their offer directly to the public to seek financial support from people who are interested. In other words, the waiting period between having an idea and raising the funds to make it a reality is significantly reduced.

How does crowdfunding work?

It sounds simple, but exactly how does crowdfunding look in practice? Well, sometimes crowdfunding campaigns seek financing in the form of donations or investments, but that’s not always the case. Some crowdfunding campaigns offer an incentive, such as special access or pricing at the launch of a product.

When setting up a crowdfunding campaign, you need to set a fundraising goal, which is usually the amount you need to get your project off the ground. You’ll also need to create a sense of urgency by setting a time limit for your campaign, ranging anywhere from a few weeks to a couple of months. Once a campaign is up and running, backers can contribute just a few dollars or even larger sums, it’s up to you to set different contribution levels or make it open.

What is the success rate of crowdfunding?

Crowdfunding success rates can vary, depending on the type of campaign and the end amount it hopes to raise. In general the more money crowdfunding campaigns aim to raise, the less successful they tend to be.

Data from February 2023 shows that the chances of achieving a fully funded crowdfunding campaign on the platform Kickstarter was 40.2%. This means 4/10 campaigns on the platform were fully funded, while 6/10 were unsuccessful in reaching the full intended amount.

  • 30,237 raised less than US$1,000

  • 124,929 raised between US$1,000 - US$9,999

  • 34,059 raised between US$10,000 - US$19,999

  • 35,666 raised between US$20,000 - US$99,000

  • 9,705 raised between US$100,000 - US$999,999

  • 704 raised US$1M

The main benefits of crowdfunding

Some of the main elements of using crowdfunding to raise money for a business include:

  • Access to funding: Crowdfunding allows you to access funding from a large pool of potential backers who may be interested in supporting their project or product. This can provide a way to secure funding when traditional financing options may not be available.

  • Validation of your business idea: Crowdfunding campaigns can serve as a way to test the market and validate the demand for a product or service. A successful campaign can provide evidence that there is interest in the project or product, which can help as you write your business plan and plot your businesses's path to profitability.

  • Marketing and promotion: Crowdfunding campaigns require creators to promote their project and engage with potential backers, which can help to raise awareness of the project and generate buzz. This can also provide valuable exposure for the creator and their business.

  • Early adopters: Backers of crowdfunding campaigns are often early adopters who are passionate about the business idea or product. This can provide a way to build a community of loyal supporters who can help to spread the word and provide feedback on your business.

  • Control and ownership: Crowdfunding campaigns allow you as an entrepreneur to maintain control and ownership of your business or project, as you are not required to give up equity or control to investors as you might have to with other types of business funding.

Drawbacks to crowdfunding

While crowdfunding can often be a quick and successful way to fund a business idea, there are a few potential drawbacks to bear in mind when starting a crowdfunding campaign.

  • Risk of failure: Crowdfunding campaigns are not guaranteed to be successful, and if a campaign doesn't reach its funding goal, you may end up not receiving any funding. This can be a significant risk in terms of the loss of time and resources invested in setting up, managing and sharing the campaign.

  • Time and effort invested: Running a successful crowdfunding campaign requires significant time and effort, including developing a marketing strategy, creating engaging content, and engaging with potential backers. This can be a challenge if you're at the stage where you're still heavily focused on developing your product or service.

  • Fees and costs: Crowdfunding platforms typically charge fees for their services, which can range from 5% to 10% or more. At the same time you may also incur costs for rewards, shipping, and other expenses associated with the campaign.

  • Public disclosure: Crowdfunding campaigns are often public, which means that information about your product or service may be disclosed to competitors at a very early stage. This can be a concern if you're developing proprietary technology or products.

  • Legal and regulatory compliance: Crowdfunding campaigns may be subject to legal and regulatory requirements, such as securities laws or consumer protection laws. Make sure to seek legal advice and ensure that they're complying with all relevant laws and regulations.

The 6 main types of crowdfunding

There’s no one-size-fits-all answer to the broad question of “what is crowdfunding?” In fact, there are a few different methods of crowdfunding. What works for raising funds to start a business may not work for someone looking to raise money for charity. It’s important to understand the advantages of different types of crowdfunding to find one that fits your goals and campaign.

Let’s take a look at six types of crowdfunding campaigns and how to best use each one:

1. Reward

5. Equity

01. Reward

Who’s it for: Entrepreneurs selling or producing client-facing products

Popular platforms: Kickstarter, Indiegogo

Average crowdfunding amount: $100,000 or less

For reward-based crowdfunding, people are incentivized to back a project because they’ll earn something in return. This type of campaigns is often used to back ideas such as new tech products or other creative ventures that are typically released by small companies or startups and work really well for B2C products.

Usually, reward-based crowdfunding will offer tiered donation suggestions, with each level of donation providing the backer with a specific prize. For example, a company that’s looking for donations to create a new weather-proof backpack might offer a steep discount when the product launches with a $20 donation or a free backpack with a $50 donation.

Kickstarter is one of the leading platforms in reward-based crowdfunding

02. Donation

Who’s it for: Non-profits, charities

Popular platforms: GoFundMe, FundRazr

Average crowdfunding amount: Around $10,000

Donation-based crowdfunding campaigns are usually run by nonprofits or other charitable organizations to help drum up funding and support. You’ll typically see smaller nonprofits or local organizations using platforms like GoFundMe for a specific cause, such as donations to buy animal shelter supplies. Larger NGOs or charitable organizations are more likely to run campaigns directly through their own platforms.

Aside from charities, you can also have individuals who are looking for donation-based fundraising to help cover the costs of a major event. It could be donations for a medical procedure or home renovation following a natural disaster, or even people looking to fundraise for a race or adventurous trip with a fundraising element.

GoFundMe is one of the most popular donation-based crowdfunding sites among non-profits and charities

03. Peer-to-peer

Who’s it for: People looking for a personal loan

Popular platforms: LendingClub, Prosper

Average crowdfunding amount: Personal loans of up to $40,000

Also called debt crowdfunding, peer-to-peer crowdfunding is when people seek out loans from other channels so that they don’t need to go the traditional route and apply through a bank. While usually marketed as personal loan lenders, platforms like LendingClub and Prosper rely on crowdsourcing to connect lenders with people looking for loans.

The advantage of this type of fundraising is that it gives you access to funds quickly, securely, and in a way that is accessible to almost anyone. While some people might find it difficult to figure out how to get a business loan through a bank or have been previously rejected, these crowdfunding sources give people the opportunity to apply and receive a loan in a different way.

Prosper focuses on peer-to-peer crowdfunding for personal loans

04. Real estate

Who’s it for: Anyone looking to invest in real estate without complications

Popular platforms: RealtyMogul, Fundrise

Average crowdfunding amount: $1,000-$100,000 minimum investment, depending on the project

Before you get too excited, no, this doesn’t mean you can crowdfund to afford your first home. Real estate crowdfunding is for people who are looking to invest in real estate but want to avoid all the red tape that comes along with it, like dealing with contracts, agents, or brokers. As a combination of investing and crowdfunding, real estate crowdfunding allows contributors to back a specific real estate project in return for equity in the property.

Due to the nature of this type of crowdfunding, real estate projects are usually commercial buildings. The advantage of this type of crowdfunding works well for contributors since it provides a simple, flexible, and low-cost alternative to investing in real estate, which is often seen as out-of-reach for many people.

Real estate crowdfunding sites such as Fundrise are primarily used to fund commercial buildings

05. Equity

Who’s it for: Businesses or startups

Popular platforms: AngelList, SeedInvest

Average crowdfunding amount: $100,000 or more

Equity crowdfunding gives investors the opportunity to invest in private companies or new startups. However, this isn’t the same as rewards or donation-based crowdfunding, but rather it’s a more conventional way to raise money for a business. As an investor, you’ll have a stake in the company that matches your investment, and you can contribute amounts as small as $500 to get started.

Many startups turn to equity crowdfunding platforms since they can show their product or idea to a greater number of investors. Not only that but unlike with more traditional forms of investments, like venture capital, investors don’t have any sort of ownership of the company, meaning a startup can retain control over its business.

AngelList is aimed to investors looking to fund private companies and startups

06. Royalty

Who’s it for: Businesses and startups

Popular platforms: AngelList, Quirky

Average crowdfunding amount: $5,000-$250,000 depending on the project

Royalty-based crowdfunding can be used by businesses that don’t want to give away a lot of their revenue from all their ventures. For example, if a startup is developing a new app or platform that runs on subscriptions, they might need funding to finish the project. In a royalty-based campaign, investors will get their money back only after the product launches and generates income.

Unlike other forms of crowdfunding, royalty-based investors don’t have a stake in the business and will only get money back from the specific project they invested in and not from the company or startup as a whole. In other words, once that app we mentioned before earns money from subscriptions, contributors will earn royalties based on the amount they invested.

Quirky offers royalty-based crowdfunding for businesses that don't want to give away a lot of revenue

10 crowdfunding tips for a successful campaign

After choosing the type of crowdfunding campaign you want to use and selecting the best crowdfunding site for your project, you’re ready to launch your campaign and start earning investments.

As an entrepreneur, you may think that your idea is one-of-a-kind and that alone will translate into investments from contributors. We hate to burst your bubble, but there are hundreds if not thousands of other entrepreneurs who think the same and are also vying for funds on the same platforms. Therefore, you need to ensure that your project stands out from the rest and attracts the right contributors.

Here are the best crowdfunding tips for a successful campaign:

01. Tell a story

Don’t just jump straight into promoting your startup or product. Sell it with a convincing story to give backers an idea of the project’s roots, and don’t be afraid to tug on a few heartstrings. Tell potential contributors about what problem you’re addressing with this new venture, what you hope to accomplish, or how you got started.

02. Create an engaging video

A well-made video has the potential to go viral, and when looking for investments, that’s exactly what you want. You can use a high-quality video to showcase your product, introduce your startup’s founder or CEO, or tell your business’s story in a more creative way than just a block of text.

03. Optimize your social media strategy

The thing about crowdfunding these days is that there are a lot of campaigns that the average person is exposed to regularly. Focus on spreading updates and news of your campaign on social media so that it can reach as many people as possible. A mix of strong content and a good call-to-action is likely to lead to a lot of traffic to your crowdfunding campaign page.

04. Keep an open line of communication

Backers of your project want to know what’s going on with the money they’ve invested. Is there a delay in production? Do you need to increase your target fundraising goal? Be transparent in what’s going on with your business and provide regular updates of your progress both during the campaign and after it ends. You never know, your backers could soon become your loyal customers.

05. Provide different giving levels

This is primarily for rewards and donations-based crowdfunding campaigns, but by offering business funding options for lower-level donations and levels of larger amounts, you can attract a wider audience of contributors. Not everyone can afford to invest or donate hundreds or thousands of dollars, but when you offer a reward, even for a small amount, it incentivizes more people to participate and engage with your business or charity.

Build a successful crowdfunding campaign by offering different rewards on donations

06. Stalk the competition

Ok, we don’t mean literally stalk, but it’s a good idea to keep tabs on what your competitors are doing so that you can remain one step ahead. You should also research your competitors in your research phase so that you can get an idea of what crowdfunding in your niche looks like and what methods have worked in the past.

07. Set your budget

You might initially think that crowdfunding is all about earning money, but you need to consider the cost of running your campaign. Whether you’re hiring people to help run your campaign, building a new website, or if you simply need to pay fees to the crowdfunding platform, these costs can add up and should be factored in from the get-go.

08. Focus on the first 48 hours

There should be a big lead-up to the launch of the campaign where you run promotions to create awareness and hype around your project. After that, the first 48 hours following the launch are critical in building momentum for a successful campaign.

09. Get creative with rewards

Aside from offering backers a product or a discount, find other creative rewards to incentivize them to invest. This is also great for charities or nonprofits that don’t have rewards to give. You can provide contributors with creative prizes like a personalized thank you video, dinner or event in their honor, or even just a shout-out in a newsletter.

10. Deliver as promised

Lastly, the most important thing you can do after a campaign is over is deliver what you promised your backers. Again, be transparent about updates or expectations, but failing to deliver or under-delivering will impact the success of any future crowdfunding campaigns you attempt and can be harmful to your brand.

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