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What Is Crowdfunding?

Simone Johnson
Simone Johnson

Need funds for your business? Here's what you should know about crowdfunding.

  • Crowdfunding is when a "crowd" funds a project or business, rather than one or two major investors. 
  • There are four different types of crowdfunding: rewards, donation, debt and equity.
  • To run a successful crowdfunding campaign, you need to capture the attention of a large number of backers and convince them that your project is worthy of their investment.
  • This guide is for startups and small business owners who are interested in learning how crowdfunding can be used to obtain funding.

Crowdfunding is when businesses, organizations, or individuals fund a project or venture with small donations from many people. By receiving the necessary boost to cash flow, these ventures can get off the ground or launch new projects. Most of these campaigns happen via internet platforms, have set timeframes for when money can be raised and disclose specific monetary goals.

Types of crowdfunding

While there are four types of crowdfunding, each has the same premise of receiving money from interested donors. Here's a breakdown of each one:

  • Donation: Donation-based crowdfunding is when people give a campaign, company or person money for nothing in return. Let's say you create a crowdfunding campaign to purchase new equipment for your company. The individuals who give you money do it out of support for the growth of your business and nothing else.

  • Debt: Debt-based donations are peer-to-peer (P2P) lending, which is a form of crowdfunding. In debt-based donations, the money pledged by backers is a loan and must be repaid with interest by a certain deadline.

  • Rewards: This is when donors receive something in return for their donations. The rewards vary by the size of the donation, which incentivizes higher contributions. Based on how much money participants give to a campaign, they may receive a token like a T-shirt, product or service – often at a discounted rate.

  • Equity: While some crowdfunding campaigns don't allow backers to own a portion of the company they're supporting, 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 where participants receive shares in the business based on how much money they contribute.

Key takeaway: There are four kinds of crowdfunding campaigns you can use for your business. With donation-based funding, contributors give money without receiving anything in return. In equity funding, backers get shares of the business. For debt-based funding, donors are repaid with interest. With reward-based funding, contributors receive tokens, products or services in return for their donations.

 

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Examples of successful crowdfunding sites

There are many online crowdfunding platforms you can use to kick off your business. Here are four of the top crowdfunding sites you can use to grow your company. 

Kickstarter

Kickstarter is a rewards-based donation platform that has been helping companies raise money since 2009. It has been used to raise more than $5 billion for more than 182,000 projects. Part of what makes Kickstarter so successful is how simple the site is to use. You set a monetary goal and the amount of time you want to reach it, 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, and although it's famously used for more charitable initiatives, businesses can take advantage of the platform as well. This is a great option for nonprofit organizations and businesses that have service-based initiatives. Statistically, 1 in 10 campaigns is fully funded on the site.

LendingClub

LendingClub is a debt-based crowdfunding site because it is a P2P lending platform. 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% of the business, and it 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 goal for a certain amount of money, and if you don't reach your target, all funds are returned to donors. Flexible funding is when you're looking for any amount of monetary support, all of which you can keep whether you hit your goal or not.

Key takeaway: Successful crowdfunding companies provide resources that help campaigns reach their funding goals. Kickstarter, GoFundMe, LendingClub and Indiegogo are some of the most reputable and successful.

Crowdfunding rules

Most crowdfunding sites have specific rules for use. Kickstarter, for example, doesn't allow equity crowdfunding and has a list of prohibited items that you are not allowed to include in your project. It's wise to read these rules thoroughly before choosing a platform so you don't have to halt your campaign before it even starts.

If you ignore the rules and jump into your crowdfunding campaign, the likelihood of success plummets. You need to adequately research the different crowdfunding sites so you understand which platform works best for your business.

Key takeaway: Before choosing a crowdfunding site, review each one's rules to ensure you choose the right one for your campaign.

The challenges of crowdfunding

Many individuals assume crowdfunding is an easy or free way of making money, but it requires a lot of effort to establish a project that backers will perceive as a valuable service. Success isn't guaranteed, and as crowdfunding continues to gain popularity, backers have become shrewder in the projects they support.

"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," said Kendrick Nguyen, CEO and co-founder of crowdfunding platform Republic.

Generating this type of widespread support can be a challenge. It takes a strong marketing effort, trustworthy founders and a quality product. According to Ryan Sim, managing director and co-founder of We The People – a company that sells only crowdfunded products – the challenges of crowdfunding are extensive. He listed five key challenges that plague reward-based crowdfunding campaigns:

  1. Finding and implementing a cost-effective marketing strategy before, during and after the campaign
  2. Crafting the right messaging in the campaign description that will drive interest in the product or service
  3. Developing an informative and exciting campaign video that explains the product and its benefits (the main challenge being that it's expensive to create a really good and high-impact video)
  4. Creating and planning the rewards program to strategically maximize the ROI 
  5. Finding the most effective and cost-efficient fulfillment method for the rewards

"It's important to note that these challenges are just the start of the obstacles to consider when creating a crowdfunding campaign," said Sim. "In addition to typical ones, every creator will have his own challenges that are very unique to his or her business."

Other challenges also arise in equity crowdfunding. According to Connor Young, founder and CEO of Ample Foods, equity crowdfunding requires more emphasis on educating potential investors who don't necessarily have an investment background.

"We're all so used to buying products online, so investing in a regular crowdfunding campaign is quite easy," said Young. "You just say, 'Oh, OK, I'm basically pre-purchasing a product that doesn't exist yet, and I'm going to get it in 6-12 months.' That's pretty easy to understand. But for a person who's not actually used to investing into companies – they're not a typical angel investor – equity crowdfunding naturally has more resistance."

You can overcome the challenges for both types of crowdfunding, however. Ample Foods raised over $370,000 from its Indiegogo campaign back in 2016 and surpassed its equity crowdfunding goal[Looking for an alternative small business loan? Check out our best picks.]

Key takeaway: It takes a lot of work to run a successful crowdfunding campaign; launching one doesn't guarantee success. It's important to make sure your marketing message is well thought out and to find cost-effective methods to promote your campaign and reward backers.

Crowdfunding benefits for investors

Investors have a lot to gain from putting their money into crowdfunding campaigns. 

  • Investors appreciate a low-risk venture, and crowdfunding offers just that. Since it's not part of the financial market, investors don't have to worry about the effects of the economy or stock market impacting their investment.
  • It's easy to invest in a crowdfunding campaign. Investors can put money into a project or company through a direct online process.
  • Equity crowdfunding allows investors to fund multiple campaigns, which helps them to expand their financial opportunities and diversify their portfolios.

Key takeaway: Investing in projects through crowdfunding sites is easy, with flexible and direct payment options. Investors can use crowdfunding to diversify their portfolios.

Tips for crowdfunding success

There's no one-size-fits-all approach to crowdfunding, but there are three key places to start on your road to crowdfunding success.

1. Communicate with backers.

Young stressed the importance of being transparent with backers throughout the process, even after the campaign ends. He explained that nearly every product launch experiences delays, so you have to expect things to go wrong and react with honesty and transparency.

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

Toward the close of the campaign, it's often good to update the community, explaining where to reach you next and whether you plan on shifting focus to preorders through your own website.

Don't be shy about keeping your backers in the loop once the campaign ends. A successful crowdfunding campaign centers on fostering relationships with supporters.

2. Share relevant and engaging marketing materials.

A good batch of marketing materials 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 said. "One of the really big reasons why someone invested in the first place to Ample 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, it's important to make your campaign stand out from the others. Creating strong marketing materials and spreading the campaign through your network tend to be the best ways of gaining recognition. Ample used a brief video to explain its product during its first crowdfunding campaign.

3. Prepare for the campaign.

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

Creating the proper marketing materials also takes time. Don't try to film an educational video the day before the campaign starts; give yourself time to get it right. Taking a few extra weeks to develop a plan and build excitement around the campaign can help you hit your crowdfunding goal.

Key takeaway: To reach your funding goal, you must do more than launch a crowdfunding campaign for your project. Market to your base before and during your campaign, and provide updates on your business's progress to develop a relationship with your backers.

Examples of successful crowdfunding campaigns

Not all projects succeed. Few of them even obtain significant levels of funding.

Many projects with excellent ideas end up failing, whereas others with simple premises flourish beyond all expectations. Crowdfunding projects tend to follow a viral method of growth and, as such, are quite unpredictable without the proper marketing.

"One of my favorite investment campaigns on [Republic] to date was RadioPublic," Nguyen said. "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."

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.

Key takeaway: The success of your crowdfunding campaign depends on your ability to capture the interest of many people and build a relationship with your base.

Concluding a campaign

Once your crowdfunding campaign closes, one of three things happens:

  1. If the campaign didn't reach its target amount, funds are returned to the backers. Some crowdfunding websites still allow you to collect all the money you raised if you fail to reach your goal, though often at an additional expense.

  2. If the campaign was successful, you receive the total amount of money you raised, minus processing fees. For example, Kickstarter charges a 5% fee for hosting the fundraiser and a percentage-based fee for payment processing. These payments are only required for successful crowdfunding projects and will not be charged to any that don't reach their goal amount.

  3. Equity crowdfunding campaigns differ in their conclusion process, as you still have an obligation to the backers. That obligation depends on how the donations play out. 

While crowdfunding does not guarantee the success of a project or the longevity of a company, it helps many entrepreneurs gain business experience and create relationships for other opportunities. 

Key takeaway: If you don't hit your funding goal, the crowdfunding platform usually returns the money to donors, though some sites let you keep the funds for a fee. Be aware of any processing and hosting expenses as well. 

Bennett Conlin and Ryan Goodrich contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.

Simone Johnson
Simone Johnson,
Business News Daily Writer
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Simone R. Johnson was born and raised in New York City. She graduated from the University of Rochester in 2017 with a dual degree in English language media and communications and film media production. She has been a reporter for several New York publications prior to joining Business News Daily and business.com as a full-time staff writer. When she isn't writing, she enjoys community enrichment projects that serve disadvantaged groups and rereading her favorite novels.