Crowdfunding is a means of raising small amounts of money from a large number of people to fund a new product, cause, or business.
Unlike traditional sources of funding, where founders and their companies seek larger amounts from relatively few sources of funding (banks, angel investors, and venture capitalists), crowdfunding solicits small amounts of money from a large number of investors.
Crowdfunding is typically carried out online via a crowdfunding platform- a crowdfunding site designed to allow project creators to create a campaign to solicit money from supporters of their idea.
How Does Crowdfunding Work?
Crowdfunding allows the creators of a product, creative work, or business to organize a campaign on a crowdfunding platform where they describe, showcase, and pitch their product, creative work, company, or idea. They then market their campaign and solicit the crowd to contribute to their project, oftentimes in exchange for the promise of a reward, to be paid back, or with equity in the company.
Types of Crowdfunding
Depending on your project or startup, there are several types of crowdsourcing that have emerged over the past 20 years, each with unique funding models, along with its own advantages and disadvantages.
Donation-based crowdfunding is a type of backer-supported crowdfunding where the campaign creator(s) ask backers to contribute to a campaign without any type of reward or stake in the venture.
Donation-based crowdfunding is the oldest (and one of the most popular) types of modern-day crowdfunding and is most often associated with charities and social causes.
Although the pros of donation-based crowdfunding (like not having to deliver rewards or give up an economic stake in the company) are readily apparent, individuals and for-profit ventures may have difficulty relying on the charity of the crowd to raise startup project capital.
In reward-based crowdfunding, campaign supporters are promised a reward for contributing to a project. Most often, rewards include the products or services that the campaign was created to fund.
Crowdfunding raises startup capital while also allowing startups to gain exposure, build awareness, and validate their ideas with early “customers”.
Unlike many other types of new venture capital, reward-based crowdfunding does not require startups to incur additional debt or to give up ownership or equity in their venture. However, a large portion of the capital raised in reward-based crowdfunding often goes to the delivery of the rewards.
Lending-based crowdfunding (aka debt-based crowdfunding or peer-to-peer lending) is a type of investor-funded crowdfunding where campaign creators solicit unsecured loans from the crowd. In lending-based crowdfunding, campaign creators ask supporters to invest in projects with the promise of future repayment plus interest.
Compared to other forms of crowdfunding, lending-based crowdfunding does not require giving up any equity in the venture, nor does it require campaigns to offer rewards to supporters. On the other hand, unlike backer-based crowdfunding models, the capital raised through lending-based crowdfunding has to be paid back to the investors in your campaign.
In equity crowdfunding, entrepreneurs offer equity in their ventures in exchange for their campaign supporter’s investment.
Equity crowdfunding provides the potential to combine some of the benefits of crowdfunding with a funding structure similar to traditional equity funding options.
Crowdfunding Frequently Asked Questions
Who uses crowdfunding?
Crowdfunding is used by a whole range of project creators, entrepreneurs, and seed, start-up, early stage, and even later stage companies. Crowdfunding is also used by individuals, charities, and nonprofits to solicit donations, and by creatives to fund, showcase, and sell their work.
Many types of products, services, creative works, and businesses have been crowdfunded. Your industry, sector, and niche may play a role in which type of crowdfunding and which crowdfunding platform is right for you.
What are the different types of crowdfunding?
There are several different types of crowdfunding, differentiated by their terms and conditions and funding mechanism. The three primary types of crowdfunding used to raise capital for a new product, creative work, or business are reward-based crowdfunding, lending-based crowdfunding, and equity-based crowdfunding.
Which crowdfunding site is best?
Which crowdfunding site is best for you depends on your project, goals, and personal and company preferences. Each type of crowdfunding is unique, and many crowdfunding platforms cater to specific niches. You will have to weigh the pros and cons of each to decide which crowdfunding site is best for you.
Is crowdfunding legal?
Yes. Crowdfunding has been around for a number of years. However, prior to the 2012 Jumpstart Our Business Startups (JOBS) Act only accredited investors could invest in equity crowdfunding. The JOBS Act created several different classes of equity-based crowdfunding, allowing both accredited and unaccredited investors to participate in most types of crowdfunding.
What is the difference between crowdfunding vs. crowdsourcing?
Crowdfunding is soliciting the crowd for capital - money - to support a project, cause, or venture. Crowdsourcing is soliciting the crowd for ideas and knowledge. In crowdsourcing, you ask the crowd (a large number of people) to contribute information, ideas, or work (often in the form of microtasks) toward a project. In crowdsourcing, the crowd may be paid or unpaid, however the contributions are often relatively small in nature. For instance, Wikipedia is a crowdsourced knowledge base where the crowd contributes to and asks for a self-check on the information published on the site.