What Is Crowdfunding? Definition & Examples

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Small-business owners have a number of funding avenues they can take when trying to raise capital for their companies. From angel investors to traditional banks and online lenders to grants, there are different ways to raise money. In some cases, the best choice to raise capital is through a method called crowdfunding.

TL;DR (Too Long; Didn't Read)

Crowdfunding is a growing area of business funding where entrepreneurs raise money from large groups of people through specialized online platforms.

What Is Crowdfunding?

In a traditional funding model such as through a bank or investment firm, the entrepreneur is limited to a small pool of wealthy people or institutions. If the pitch or timing isn’t quite right for the audience, then the business may not receive the funds it requires.

However, the crowdfunding model is somewhat opposite the traditional funding model. In this scenario, the entrepreneur uses special online crowdfunding platforms to get his fundraiser pitch in front of hundreds or thousands of potential investors and lenders at the same time. Instead of requiring one party to invest a lot of money, several parties can invest nominal amounts, such as $20 each. In return, backers get rewards, perks or equity in the company, and a platform fee is paid out to the intermediary.

Crowdfunding can be used to raise working capital, purchase assets or expand the business. It’s important to not make general claims when asking for crowdfunding. Best practices include being specific about the uses for the money in order to convince backers to pledge to your business.

The Benefits of Crowdfunding

There are several advantages of using the crowdfunding method to raise business funds for small businesses. Being able to access a wider pool of investors is just one of the benefits that entrepreneurs can enjoy with crowdfunding. Plus, the criteria for investments and lending are more relaxed than with traditional institutions like banks, credit unions and venture-capital firms.

Some of the benefits of crowdfunding include:

  • Efficiency: Crowdfunding provides entrepreneurs with the ability to centralize their fundraising. Through a single campaign, businesses can funnel all kinds of potential investors through the process without having to research them individually and fill out separate forms or applications.

  • Speed: Getting a loan from a bank or booking a meeting with an angel investor can take weeks or longer. With crowdfunding, you can create a campaign within a matter of hours and be on your way to raising money for your business.

  • Feedback: Not only is crowdfunding a way to raise money but you can also get invaluable feedback from investors. Those who visit your crowdfunding campaign may point out weaknesses in your pitch, or they may pose important questions. Entrepreneurs can then use that feedback to improve their crowdfunding pitch or to tweak their business model.

  • Control: With crowdfunding, entrepreneurs have control over how much they want to give in return for funding. With traditional investment firms, this control doesn’t always lie with the entrepreneur.

  • Momentum: Launching a crowdfunding campaign is a great way to attract potential customers for your business. You can also learn whether your business is a viable idea based on how many people show interest.

  • Streamlined presentation: Creating a crowdfunding campaign requires entrepreneurs to polish their unique value proposition, offerings, addressable market and more. Having this information ready helps not only with the campaign page but with any other marketing or funding initiatives.

  • Increased reach: With traditional investment and lending models, an entrepreneur’s reach is limited to a small group of people or institutions. Having access to hundreds or thousands of potential investors and lenders at the same time expands the funding horizons for many businesses.

The Disadvantages of Crowdfunding

However, crowdfunding isn’t right for every business. As with all investment and lending methods, there are some serious disadvantages that entrepreneurs should consider before launching a crowdfunding campaign. Keep the goals of your business-funding initiative in mind when figuring out whether crowdfunding is right for your venture.

Some common drawbacks of crowdfunding include:

  • Possible rejection: Not all pitches are accepted on crowdfunding platforms. In fact, many crowdfunding platforms have very detailed and specific rules about what kinds of campaigns they accept. Often, close to half of all crowdfunding pitches are rejected on some platform. As a result, just because you want to use crowdfunding for your business doesn’t mean you may be able to.

  • Risk of failure: If you get rejected by a bank for a loan, you may be able to try a credit union or online lender. If your crowdfunding campaign tanks, however, it doesn’t mean you can always set up another one and hope to succeed. If your crowdfunding campaign fails, then it’s unlikely you’ll have luck with another one unless you significantly change your pitch, business model, unique value proposition or more.

  • Potential fees: Many crowdfunding platforms take a percentage of the total funds raised. These fees can range from 2% to 10%. Often, you also have to pay a percentage fee to the payment operator in addition to the crowdfunding platform.

  • All-or-nothing model: Some crowdfunding platforms have a rule where the business only gets to keep the funds raised if the initial funding goal is met. If the business doesn’t meet the funding threshold, then the money is returned to the investors, and the company gets nothing for its crowdfunding efforts.

  • Fierce competition: Because crowdfunding is so easily accessible to many people, the competition is incredibly high. At any given time, your campaign may be competing with hundreds or thousands of similar initiatives. As a result, it can be difficult to truly make your venture stand out from the rest.

  • Sharing confidential information: On many crowdfunding campaigns, businesses share specific details about their products. Some even share drawings of prototypes or design details. While this is a good way to show potential investors why your business has a chance of success, it’s also a good way to have competitors use your information for their advantage. If you’re sharing details of your products online, a competitor may find a way to use a similar design and get to the market before you.

Different Types of Crowdfunding

Crowdfunding isn’t a one-size-fits-all model. In fact, there are several different types of crowdfunding methods available with unique platforms to support each one. The kind of crowdfunding model you use will depend on the kind of business you have and your plans for long- and short-term growth.

Crowdfunding models include:

  • Donation-based crowdfunding: In this model, there is no financial return to the contributors. Typically, this kind of model isn’t used for business. Donation-based crowdfunding may be used to raise money to pay for medical bills or for disaster relief, for example.

  • Rewards-based crowdfunding: When contributors pledge an amount for your business, they receive a reward or perk in return. Rewards may include getting exclusive access to a specific product when it first comes out or getting a signed thank-you note from the CEO of the company. The rewards are not financial in nature. In some cases, businesses offer rewards in specific monetary tiers: the more people donate, the better their rewards.

  • Equity-based crowdfunding: In this model, investors become part owners of the small business in exchange for the capital they provide. While rewards-based crowdfunding is available to anyone, equity crowdfunding is typically only available to accredited investors. The amounts raised through equity-based crowdfunding are typically higher than the amounts raised through rewards-based crowdfunding.

  • Peer-to-peer lending: This model is similar to acquiring loans from a bank except that it is done with large groups of people instead of one institution. People lend money to a business and are repaid with interest based on the agreed-upon terms.
     
  • Profit-sharing crowdfunding: In this model, the business vows to share a percentage of the profits or revenue with the contributors at an agreed-upon later date in return for getting their funds now.

Popular Crowdfunding Websites for Small Businesses

There are many different crowdfunding platforms for entrepreneurs to leverage. It’s best to research the benefits and drawbacks of these fundraising tools and see how each aligns with your business goals and growth plans. Keep an eye out for the fees each platform takes and whether it has an all-or-nothing policy in place.

Successful crowdfunding sites for small businesses include:

  • Kickstarter: This is a highly competitive platform that is only for creative projects. It keeps 5% of successful campaigns, and it has an all-or-nothing rule. So if you don't quite hit your fundraising goal, you don't get any of the funds.

  • CircleUp: Consumer brands that are looking for an equity or credit-based model use this platform. It connects entrepreneurs with accredited investors who have a net worth of at least $1 million. Keep in mind that it has an all-or-nothing policy.

  • Fundable: This is a good platform for businesses that are looking to expand. There is no percentage fee, but it does have a monthly fee that is taken whether or not your campaign is successful.

  • Indiegogo: This platform is particularly good for tech businesses; however, its fees are in the range of 8% to 10%. One of the major benefits is that you have the option to keep whatever you raise, even if you don’t meet the funding goal.

  • LendingClub: This platform connects borrowers with lenders. Investors contribute to loans in exchange for high returns. It’s best to use this platform if you have large, one-time expenses, such as purchasing new machinery for your business.

Operating a successful crowdfunding campaign could be dependent on your platform selection as well as your pitch. Tailor your crowdfunding projects carefully to your target market.

How to Create a Successful Crowdfunding Pitch

In order to get noticed by the crowds and stand out in the highly competitive space, your crowdfunding pitch needs to share your business’s unique story. Succinctly tell contributors about yourself, your passion and why they should pledge an amount to you. It’s important to share your goals for the funding so that people know what you plan to do with the money.

It’s best to be as specific as possible. For example, if you say you want to raise $20,000 to “grow your business,” this doesn’t tell potential investors how you will do that. However, if you say you need $20,000 in order to purchase a new piece of equipment that will help you increase production and revenue, then that’s a more effective way of sharing your goals.

Other ways to ensure your crowdfunding pitch is successful include:

  • Creating a communication plan before your launch: Issue press releases, have a social media campaign and inform potential investors and lenders about your plan to launch a crowdfunding campaign. This initial boost in interest can help your campaign take off.

  • Focusing on the video pitch: Almost all crowdfunding platforms allow businesses to share a short video outlining the pitch. It’s one of the most successful methods to obtain the interest of your audience.

  • Offering enticing rewards: If you want to encourage people to pledge to your campaign, figure out what you want to give them in return. Be realistic about what you can afford. Keep in mind that your campaign isn’t over until you have fulfilled your promise to all of your backers.