Summary: What is crowdfunding and how do I use it?
What is crowdfunding and how do I use it?
Are you thinking of starting a business? Are you in the early stages of developing your company and are looking for ways to get some capital? Then, before you go to angel investors or seek out venture capital firms, you may want to consider the option of crowdfunding.
What is Crowdfunding?
Crowdfunding is exactly what it sounds like: getting donations (or investments) from a large group of people in order to raise money. In other words, it is literally asking a crowd of people for funding. The benefit of crowdfunding is you can ask a lot of people for a little bit of money (think $1-$100) as opposed to asking a handful of people for a lot of money (think $100,000-1$,000,000). This is primarily a process that happens online where those seeking the capital can use social media and digital marketing to easily share their funding requests (called “campaigns”).
If you have ever heard of companies like Kickstarter, Indiegogo, or GoFundMe, you might be familiar with the concept of crowdfunding already. But did you know there is more than one type of crowdfunding method?
Types of Crowdfunding
There are many different types of crowdfunding, some of the most popular are: donation, reward, debt, and equity. Let’s talk a bit about each one, what they are, and how they differ from one another:
Donation-based crowdfunding fits the more traditional understanding of crowdfunding and is literally a donation. An individual would give a small sum of money to a person or a company they want to help, with no expectation of any gift or reward in return. This is often seen in platforms like GoFundMe to help cover people’s medical expenses (hooray, United States healthcare system…but that’s a topic for another day!)
Unlike donation-based crowdfunding, reward-based crowdfunding gives a reward to people who donate. This is a model you may be familiar with from companies like Kickstarter. Rewards individuals receive are often proportional to the amount of money they give to a particular funding campaign (the more money you spend, the bigger the reward) and the “rewards” are often the very products the fundraiser is using the money to create (so think a “presale” model where you as the supporter are providing money to create the first production run of a new product and you receive that product as your reward).
Debt-based crowdfunding is essentially a way to receive funding through loans that the individual or company will have to pay back over time. This is often referred to as peer to peer lending. You as the supporter of a debt crowdfunding campaign usually earn interest in exchange for your contribution.
Equity-based crowdfunding is a way for a company to gain capital by giving away equity in the venture that is trying to raise money. In other words, the people that give money to help you grow, do so in exchange for a percentage (ie., stock) of the company.
Pros and Cons:
Ok, so now that you know a little bit more about crowdfunding, let’s discuss some of the pros and cons of using crowdfunding as a way to raise money for yourself or your company. Keep in mind this is not an exhaustive list of pros and cons, but here are a few:
Avoid bank lending
Because there are donation and reward-based funding options for your business there is no need to worry about trying to get a loan from a bank for your business. This also means you don’t have to worry about a bank not wanting to take the risk on your business and denying you a loan. You also will not have the additional burden of paying back the funds.
Because you are not relying on angel investors or venture capital, you are not losing any stake in your company and therefore you are able to make all the decisions about your business without having to worry about the desires of investors.
Tests your Business Model
Crowdfunding gives you a really good way to determine whether or not your business is something that consumers want. If you are funded quickly, and you reach or exceed your funding goals, then you know you have a product or a business model that people want!
Like most things that come with growing a business, crowdfunding money for your next venture takes time. You have to be prepared to market your product, if you are using reward-based systems you have to determine what rewards you are distributing, and how you are going to send out those rewards at the end of your fundraising campaign. Keep in mind that marketing, creating advertisements, etc. not only takes time but also costs money as well.
If you use popular platforms like Kickstarter to raise money, then you are going to lose a percentage of what you raise during your campaign to the host company. How much you give to the platform depends on the service itself, Kickstarter, for example, takes a 5% fee plus an additional 3-5% payment processing fee, for any project that is successfully funded.
Once you have launched your fundraising campaign, you often cannot change what you are saying or doing. That includes descriptions of your campaign and the length of time you are raising money.
As previously mentioned, there are a lot of pros and cons when it comes to crowdfunding, and those can change depending on the type of crowdfunding you want to use. But these are some of the more important things to keep in mind. Do you have more questions? Do you have topics of interest you'd like us to cover? Drop a comment or hit us up via the live chat tool on the bottom right of this website and let us know!