What is crowdfunding?

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Crowdfunding investment is a way for individuals and businesses to raise money required from multiple small investors, usually via an online crowdfunding platform.

It's often a very targeted way to invest. Supporters browse crowdfunding sites and look for an opportunity they find interesting, or hear about new ventures and inventions via social media and word of mouth. 

From there, investors pledge a certain level of support. Pledges can be a charitable donation but usually involves some form of reward, either as material goods, interest on the loan, or an equity stake in the business. 

Investors get close control over where their money goes, small businesses and new startups get access to the finance they need, and the crowdfunding platform typically offers some level of protection to both sides in the arrangement.

Crowdsourcing funding for business startups has become increasingly popular in recent years as online finance platforms have matured and word of mouth via social media has become part of everyday life. 

Now crowdfunding is a standard tool for entrepreneurs and microbusinesses to raise the funds they need to grow, or to get a new idea, invention or innovation up and running without turning to bank loans and institutional investment.

What is crowdfunding for small businesses? 

Raising money via crowdfunding is a way to generate seed finance and to cover setup costs like prototyping and a first full-scale manufacturing run. 

Startups also use crowdfunding for other purposes, such as to expand an already established business or to launch a new product or service, especially one that fills a gap in the market with demand from customers and potential crowdfunding investors.

Small business crowdfunding investment can come from individuals all over the world, with each person willing to 'chip in' a relatively small amount of money towards an overall target.

In this way, crowdsourcing funding for startups allows you to build momentum and awareness to raise a higher overall sum before your crowdfunding deadline, and hopefully gives you 100% of the money you need by that time.

You might not have equity to give to investors, and you might not be able to commit to repaying their money with interest. 

However, if your idea is good enough, you might be able to raise funds without promising anything at all in return. 

Or you could promise tangible or intangible rewards, ranging from the first edition of your finished product to something that costs you nothing, such as a thank you or shout-out on your website, in a video, or even somewhere on your physical product itself.

What platforms are used for crowdfunding? 

Different platforms offer different ways to raise funding for startups and individual entrepreneurs.

Some platforms - especially in peer-to-peer crowdfunding - accept investment from individuals and institutions alike. 

Others are limited to individual investors only, and these are often more donation-based or rewards-based, with individuals buying into a 'passion project' because they believe in it, not for financial gain. 

For small businesses looking to raise funds through crowdsourcing, this means they can choose from plenty of different platforms. 

One of the main differences between the different crowdfunding platforms is the type of crowdfunding they use. 

We've already mentioned peer-to-peer crowdfunding and charitable donations, but let's take a look at four of the main types of crowdfunding platforms that small businesses have available to them.

Some of the most popular crowdfunding websites for new businesses include:

  • Kickstarter
  • Indiegogo
  • Gofundme
  • Crowdrise

What types of crowdfunding are there?

There are several main types of crowdfunding campaigns. The difference is usually the way investors are paid back or rewarded for their investment.

Some of the ways businesses reward their crowdfunding investors include paying back cash with interest, giving them an equity stake, or some other incentives or rewards.

For example, if a business raises funds through crowdfunding projects for manufacturing, they might pledge to send each investor the finished product.

Equity crowdfunding 

On equity crowdfunding platforms, investors buy a share in the business. Because of this, the company needs to have some perceived value upfront.

For example, if the total stake on sale is 25% and the total amount the business wants to raise is $250,000, that puts a valuation of $1 million on the whole venture.

Investors might want to see some proof of this before putting their money at risk, and the business owners lose a stake in their own company too.

Peer-to-peer crowdfunding

Peer-to-peer crowdfunding, otherwise known as peer lending, is similar to a traditional personal loan, except that the money the business receives is crowdsourced.

There are numerous P2P lending platforms where individuals and institutions can lend to individuals and businesses. 

In most cases, the business pays back the loan with interest but retains 100% of its equity stake. This method leaves no long-term relationship with the investors once it pays back the loan in full.

Rewards-based crowdfunding 

Rewards-based and incentive-based crowdfunding is a popular way for microbusinesses to get off the ground.

Startup businesses often use this method to cover the costs of an initial production run, for example of a new gadget, tool or game.

Instead of a cash reward, backers receive an incentive, usually in the form of a goody bag containing the finished product and other related perks, memorabilia or experiences.

Donation crowdfunding

Donation crowdfunding is more usual for individuals but less so for businesses. It relies on a large number of people putting money into your venture out of a spirit of goodwill.

For individuals, this is often a way to cover medical costs or rebuild a home damaged by a natural disaster or another similar incident.

Small businesses looking for donation crowdfunding investment might need to show some benefit to their local community, wider society or humanity as a whole, so investors know their money is going to a worthy cause.

What are the benefits of crowdfunding? 

Crowdfunding has become a popular way for individuals and small businesses to raise the money they need for a particular project, usually an innovation or invention.

It's an excellent way to raise funds with guaranteed sales of the completed item, such as in the case of rewards-based crowdfunding where people pledge money in return for receiving the finished product.

The total amount of money you can raise from individuals is unlikely to compare with the funds available to you via institutional business loans. Often that's ideal for microbusinesses who only need to cover a small manufacturing run.

For investors, benefits include the ability to support a person or business that sparks their interest. They also get to buy into a product that is not yet on sale anywhere else in the world.

What are the drawbacks of crowdfunding? 

The drawbacks of crowdsourcing funding for startups can depend on the type of crowdfunding you choose. 

In the case of equity crowdfunding, you sell off a stake in your company, and that ties you into a long-term relationship with your investors even after you no longer need their money.

Rewards-based crowdfunding commits you to send out the promised incentives, which in some cases might mean you spend all the raised funds purely to manufacture the rewards.

P2P crowdfunding means you have to pay interest to your investors, so you end up paying back more than you borrowed.

Donation crowdfunding arguably has the fewest drawbacks. But you might face closer scrutiny when it comes to proving that your venture is a worthy cause, particularly if you do not qualify for official charity or non-profit status.

Some crowdfunding platforms also impose a rule that you must raise 100% of the money you seek before a specified deadline, or else the platform will automatically refund all contributors.

You should be aware of this possibility. In some cases you might still be able to do good work using half of the money you asked for, so make sure this is an option on your chosen crowdfunding platform if so.

How does a business begin crowdfunding?

To start a successful campaign, just like any time you seek investment, you need to create your pitch.

For business crowdfunding pitches, that means writing a business plan and researching your finances and fundamentals.

Decide which method of business crowdfunding you want to use. Your prefered method might depend on what you have to offer in return, from equity stakes to cash with interest, material goods, or nothing at all if you think investors will buy into your idea as a good cause.

Your chosen crowdfunding platform will probably give you space to write your pitch. Make sure you outline the benefits of your idea or product and make clear what investors will receive in return.

If you have supportive friends and family, consider asking them to be your first investors. Even small donations will help get you off the 0% mark and can help you to appeal to investors who you don't already know.

Finally, be prepared for when you have to start paying back your crowdsourced loans or sending out material rewards and incentives.

Like any loan, crowdsourced finance represents a credit risk for your business, so it's crucial to stay on schedule with any repayments and investor 'gifts' so that your supporters get back everything they expect for their investment into your venture

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