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What Is Crowdfunding?

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Crowdfunding offers companies an alternative to traditional funding channels. / Credit: Shutterstock

Crowdfunding is when businesses, organizations or individuals fund a project or venture with small donations from many people. Put simply, a "crowd" funds a project or business, rather than one or two major investors. 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.

Participants – or backers, as they're often called – pledge a minimum amount to the fund and may receive a reward for their contribution. Rewards generally vary based on the size of a donation, which incentivizes higher donations. While some crowdfunding campaigns don't allow backers to own a portion of the company they're supporting, equity crowdfunding allows small businesses and startups to give away a portion of their company.

Many crowdfunding websites exist. Of these numerous resources, a few stand out in popularity and success levels. Kickstarter is the one of most noteworthy crowdfunding resources with a proven history. GoFundMe is another popular crowdfunding site, although it focuses more on charity and individual causes than businesses. For startups, other popular crowdfunding platforms include StartSomeGood, Indiegogo,Patreon and Republic.

Crowdfunding succeeds in integrating the traditional funding model with a modern way of driving business and welfare. While crowdfunding does not necessarily guarantee the longevity of a company, project or idea, it helps many individuals gain experience, mobilize communities and create relationships for other opportunities. [Looking for an alternative small business loan? Check out our best picks.]

The best platform for you partly depends on the different rules and uses for each crowdfunding site. Most crowdfunding sites have specific rules for use. Kickstarter, for example, doesn't allow equity crowdfunding and requires that campaigns exclude anything on its list of prohibited items. It's wise to thoroughly look at these rules prior to launching a campaign. You should understand which crowdfunding platform works best for your business to ensure you don't have to halt your campaign before it even starts.

Make sure your startup follows the rules and aligns with the crowdfunding site you choose. For example, Kickstarter doesn't allow energy food or drinks, while other crowdfunding websites do allow those sorts of projects. Look at the rules to quickly learn about the priorities of each site.

If you ignore the rules and jump into your crowdfunding campaign, the likelihood of success plummets. Make sure you adequately research the different crowdfunding sites before launching a campaign.

Many individuals assume crowdfunding is an easy or free way of making money. 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 what 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 to 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 arise in equity crowdfunding. According to Connor Young, the founder and CEO of Ample Foods, equity crowdfunding requires a larger 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 raised over $370,000 on its Indiegogo campaign back in 2016 and has already surpassed its equity crowdfunding goal with time to spare in that campaign. 

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

"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 on your own website. 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.

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.

Putting together a good batch of marketing materials helps 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 separate your campaign from the others. Marketing materials, in addition to spreading the campaign through your network, tend to be the best way of gaining recognition. Ample used a brief video to explain its product during its first crowdfunding campaign.

For the best crowdfunding results, prepare for the campaign before launching it. Spread the word to 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 yourself every chance of being found by potential backers.

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.

Not all projects succeed, and 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 more of 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."

As we noted earlier, not all crowdfunding platforms are designed for businesses. After a video of a bus monitor being bullied by students went viral in 2012, a man who had never met the monitor decided to launch a crowdfund with the goal of sending her on a well-deserved vacation. The resulting support from the media and public helped generate more than $700,000, which gave her enough for not only a vacation, but also a good retirement.

Upon the conclusion of a crowdfunding fundraiser, one of three things happens. If the fundraiser was unsuccessful in reaching its target amount, funds are returned to the backers. Some crowdfunding websites still allow companies to collect all the money they raised despite the failure to reach their goal – though often at an additional expense.

If the fundraiser was successful, the company, organization or individual receives the total amount of money raised, minus any processing fees. For example, Kickstarter charges a 5 percent fee for hosting the fundraiser in addition to another minor fee for payment processing. These payments are only required for successful crowdfunding projects and will not be charged to any that do not reach their goal amount.

Equity crowdfunding campaigns differ in their conclusion process, as the startup still holds an obligation to the backers. That obligation varies depending on how the donations play out. 

Additional reporting by Ryan Goodrich.

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