What Is Crowdfunding?

Crowdfunding Explained

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Crowdfunding is the method of financing a business venture, project, or cause by collecting small monetary contributions from a large group of people through online platforms. Those who contribute funds can be friends, family, interested investors, or even sympathetic strangers, depending on what you’re trying to fund. 

Because crowdfunding gives entrepreneurs a chance to promote their product, service, or venture to a large pool of investors with minimal financial risk, it’s important to know how it works, as well as its pros and cons. 

Definition and Types of Crowdfunding

Crowdfunding is a financing method of raising funds through the support of backers who typically contribute through an online platform. A crowdfunding campaign usually has a monetary goal in mind and a deadline set to reach it. 

There are three distinct types of crowdfunding that entrepreneurs can use to raise funds for their business:

  • Reward crowdfunding: This type of crowdfunding offers backers of your campaign rewards, such as exclusive experiences or an early version of your product or service.
  • Debt crowdfunding: This method allows lenders to loan a portion of the funds and earn interest upon the debt repayment. 
  • Equity crowdfunding: This method gives supporters investment opportunities in exchange for equity or potential future return. 

The U.S. Securities and Exchange Commission regulates equity crowdfunding.

How Crowdfunding Works

Let’s say you’re an entrepreneur who wants to go to market with an innovative product, and you decide to take the crowdfunding route to finance it. You can choose a popular platform—such as Kickstarter or Indiegogo—and follow the steps laid out by the specific platform to launch your campaign. 

When choosing where to launch your crowdfunding efforts, research your options—there are various fees involved, and some sites have an all-or-nothing approach where you don’t receive your funds unless you meet your target goal.

To promote your crowdfunding campaign, you should implement key strategies such as social media outreach on your profiles and pages, email marketing with special offers, buying targeted Facebook ads, and creating a landing page for the product itself. 

Examples of Crowdfunding

Crowdfunding can be a viable way of raising capital for entrepreneurs at any stage of their development. Side hustlers, solopreneurs, storefront business owners, and even tech startups have relied on crowdfunding. Here are some notable examples of businesses that launched as a result of crowdfunding: 

  • In 2016, smartwatch brand Pebble raised over $20 million in its Kickstarter campaign. Rival Fitbit quickly acquired Pebble that same year, but the latter’s ability to launch such a successful campaign is noteworthy.
  • Avid book reader Noelle Santos wanted to open a bookstore and wine bar in the Bronx. Santos launched a campaign on Indiegogo and raised over $150,000. She opened her bookstore, dubbed the Lit. Bar, in 2019.
  • The makers behind Fidget Cube, a product to help people remain focused while working, at school, or even at home, raised nearly $6.5 million on Kickstarter.

Pros and Cons of Crowdfunding 

Pros
    • Low financial risk
    • You keep your equity
    • Enhanced visibility
Cons
    • Limited time and large investment
    • Your campaign may be unsuccessful
    • Your idea could be stolen

Pros of Crowdfunding Explained 

Low Financial Risk

Crowdfunding provides entrepreneurs with an opportunity to raise capital without taking on considerable debt or using personal finances for inventory, materials, or development. A successful crowdfunding campaign means that you will have raised enough funds to launch or grow your business venture.

You Keep Your Equity

You will have to share rewards with your contributors if you reach your funding goal in a crowdfunding campaign. However, you will not have to give up any equity or lose control of your business. 

Enhanced Visibility 

Launching a crowdfunding campaign can be a strategic way to enhance your business’s visibility—even if you’ve yet to reach your funding goals. By developing a marketing plan around a campaign, complete with social and email outreach, an entrepreneur can develop a vital relationship with prospective clients and customers. And if a campaign generates buzz or goes viral, that can be a win-win for a small business owner who wants to raise capital—or, at the very least, create lasting brand awareness.

Cons of Crowdfunding Explained 

Limited Time and Large Investment 

Crowdfunding can help build awareness and publicity for your business, but it also comes with the pressure to deliver in a short time and may require a sizable investment in marketing (such as ads, promotional videos, etc.) in order to run an effective campaign.

Your Campaign May Be Unsuccessful

According to The Crowdfunding Center, the average success rate of crowdfunding campaigns— which means fully reaching funding goals—is only 23%. An unsuccessful campaign can also lead to bad press, harm to brand reputation, and wasted time and investments.

Your Idea Could Be Stolen

For some entrepreneurs, crowdfunding can be a viable way to gain funding for an invention. Unfortunately, it can also create the potential for your idea to be mimicked by a company with financial backing to make your dream product their own profitable reality. 

If you’re seeking crowdfunding for a business venture or product that is not already in the marketplace, ensure that the idea is protected by patents, copyrights, or even trademarks.

Even with intellectual property, however, another business can still replicate a product, which can make entrepreneurs reconsider the value of crowdfunding. 

Key Takeaways

  • Crowdfunding is a financing method to raise funds for a business venture from a large group of backers through online platforms.
  • There are three main types of crowdfunding: rewards, debt, and equity-based. 
  • Kickstarter and Indiegogo are popular crowdfunding platforms. 
  • Pros to crowdfunding include low financial risk, keeping your equity, and increasing your visibility. 
  • Crowdfunding cons include large time and marketing investments, the negative impact of unsuccessful campaigns, and the potential to have your idea stolen.