What Is Crowdfunding?
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists.
- Crowdfunding is a way for companies and individuals to raise capital from a large group of investors who can choose from hundreds of projects for as little as $10.
- There are restrictions as to who is allowed to fund a new business and how much they are allowed to contribute.
- Crowdfunding sites generate revenue from a percentage of the funds raised.
- The SEC regulates equity-based crowdfunding ventures in the United States.
- Kickstarter, Indiegogo, and GoFundMe are among the most popular crowdfunding platforms.
How Crowdfunding Works
Accessing and raising capital is key to the growth of any company. It can be easy for larger, more established corporations to raise money from investors or to take on additional debt from their lenders. Some businesses, though, may come across hurdles that can stifle their growth. This is especially true for smaller companies and startups, which is where crowdfunding comes in handy.
Crowdfunding has created the opportunity for entrepreneurs to raise hundreds of thousands or millions of dollars from anyone with money to invest. It provides a forum for anyone with an idea to pitch it in front of waiting investors.
One of the more amusing projects to receive funding was from an individual who wanted to create a new potato salad recipe. His fundraising goal was $10, but he raised more than $55,000 from 6,911 backers. Investors can select from hundreds of projects and invest as little as $10. Crowdfunding sites generate revenue from a percentage of the funds raised.
The first instance of crowdfunding was recorded in 1997 when a music group from the United Kingdom raised money for a concert tour from fans. ArtistShare, which was the first crowdfunding site, was launched three years later. Almost a decade later, it became a key source for companies to raise capital.
Crowdfunding platforms were largely unregulated when they first became popular. But things changed over time, as a number of countries, including the United States, began placing restrictions on certain types of crowdfunding.
These restrictions apply to who can fund a new business and how much they are allowed to contribute. Similar to the restrictions on hedge fund investing, these regulations are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. Because so many new businesses fail, their investors face a high risk of losing their principal.
Many crowdfunding projects are rewards-based. This means that investors may get to participate in the launch of a new product or receive a gift for their investment. For instance, the maker of a new soap made out of bacon fat may send a free bar to each of its investors. Video games are a popular crowdfunding investment for gamers, who often receive advance copies of the game as a reward.
Types of Crowdfunding
The two most traditional uses of the term reflect the type of crowdfunding done by startup companies looking to bring a product or service into the world and by individuals who experienced some type of emergency.
Many individuals affected by a natural disaster, hefty medical expense, or another tragic event such as a house fire have received an amount of financial relief they wouldn’t otherwise have had access to thanks to crowdfunding platforms.
However, in recent years, some crowdfunding platforms such as Patreon and Substack have extended the reach of crowdfunding to offer a way for creative people, including artists, writers, musicians, or podcasters, to sustain their creative work by receiving a steady source of income.
Popular Crowdfunding Websites
Crowdfunding websites such as Kickstarter, Indiegogo, and GoFundMe attract hundreds of thousands of people hoping to create, or support, the next big thing.
GoFundMe is the largest crowdfunding platform. Since GoFundMe was founded in 2010, the site has raised over $25 billion through more than 200 million donors. GoFundMe is the site most popular for individuals seeking to recover from a medical expense or disaster such as a house fire, natural disaster, or unexpected emergency expense. Start-up companies tend to use Kickstarter.
Kickstarter is another popular choice. Founded in 2009, the platform has successfully funded almost 250,000 projects, with more than $7.6 billion pledged across all Kickstarter projects.
Kickstarter is the most popular crowdfunding site for aspiring businesses hoping to raise capital and reach a larger audience. In fact, unlike GoFundMe, Kickstarter can only be used for creating projects that can be shared with others.
Additionally, Kickstarter cannot be used to raise funds to donate to a charity or cause, projects can’t offer incentives like equity, revenue sharing, or investment opportunities, nor can any project involve the site’s list of prohibited items such as “any item claiming to diagnose, cure, treat, or prevent an illness or condition,” political fundraising, drugs or alcohol, or any contests, coupons, gambling, and raffles.
Indiegogo started as a crowdfunding site initially focused exclusively on raising money for independent films but began accepting projects from any category a year after its launch in 2008.
Indiegogo is seen as a less strict and more flexible platform than Kickstarter, as it gives backers control over whether they want fixed or flexible models—this is probably the most significant difference between the two crowdfunding platforms. Kickstarter releases funds only after the campaign has reached its funding goal, whereas Indiegogo allows the campaigner to receive funding pro-rata, or wait until their target is hit.
As a campaigner, it might be easier and less risky to go with flexible funding, such as receiving funds as they come. However, regardless of the amount raised, campaigners must still deliver on any promises made. For a backer, fixed funding is more attractive as it is associated with much less risk.
Crowdfunding platform fees range from 5% to 12%. Look out for punitive fee structures before choosing a crowdfunding platform.
Advantages and Disadvantages of Crowdfunding
The most obvious advantage of crowdfunding for a start-up company or individual is its ability to provide access to a larger and more diverse group of investors/supporters. With the ubiquity of social media, crowdfunding platforms are an incredible way for businesses and individuals to both grow their audience and receive the funding they need.
Equity-based crowdfunding is growing in popularity because it allows startup companies to raise money without giving up control to venture capital investors. In some cases, it also offers investors the opportunity to earn an equity position in the venture. In the United States, the Securities and Exchange Commission (SEC) regulates equity-based crowdfunding.
Potential disadvantages of crowdfunding include the possible damage to you or your company’s reputation caused by “resorting” to crowdfunding, the fees associated with the crowdfunding site, and, at least on some platforms, if you don’t reach your funding goal, any finance that has been pledged will be returned to your investors and you will receive nothing.
Examples of Crowdfunding
Many of the products and businesses crowdfunded on Kickstarter became very successful and lucrative endeavors. For instance, Oculus VR, an American company specializing in virtual reality hardware and software products, was funded through the site. In 2012, founder Palmer Luckey launched a Kickstarter campaign to raise money to make virtual reality headsets designed for video gaming available to developers. The campaign crowdfunded $2.4 million, ten times the original goal of $250,000. In March 2014, Meta (META), acquired Oculus VR for $2.3 billion in cash and stock.
Another example of a company that rose to success through the help of Kickstarter campaigns is M3D, a company founded by two friends that manufacture small 3D printers. David Jones and Michael Armani raised $3.4 million for their Micro 3D printer on the crowdfunding site in 2014. The tiny 3D printer, which comes with a variety of durable 3D inks, is now available at Staples, Amazon (AMZN), Brookstone, and elsewhere.
In April 2019, Critical Role, a weekly live-streamed tabletop roleplaying game featuring a group of prominent voice actors, raised $4.7 million in just 24 hours for its latest animated special “The Legend of Vox Machina.” No other 2019 Kickstarter campaign raised that amount over their entire 30- to 60-day raising period.
What Is Crowdfunding and How Does It Work?
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Depending on the type of crowdfunding, investors either donate money altruistically or get rewards such as equity in the company that raised the money.
Do You Pay Back Crowdfunding?
For crowdfunding that operates on a donation basis, the company does not need to pay back investors. However many companies offer incentives for early backers such as an advance copy of the product.
Is Crowdfunding Legal in Australia?
Yes. In 2017, the Australian government amended the 2001 Corporations Act to provide a legislative framework for crowd-sourced funding.
Is Crowdfunding Legal in Nigeria?
All micro small and medium enterprises incorporated as a company in Nigeria with a minimum two-year operating track record are eligible to raise funds through a Crowdfunding Portal, in exchange for the issuance of shares, debentures, or such other investment instrument as the Commission may determine from time to time.
The Bottom Line
The digital age has given rise to crowdfunding, which is a unique way for organizations and individuals to amass (a large amount of) capital from a big group of people. For those seeking capital, it’s as developing a great pitch and setting a target on a crowdfunding site like GoFundMe or Kickstarter. Large donations may be desirable, but it’s often the smaller donations that add up and allow capital seekers to reach their goals.