Crowdfunding, Small Business

Crowdfunding: Explained

You may have heard of crowdfunding but do not fully understand what it is. After spending three years of reading academic journals, mass media articles, and interviewing a few successful crowdfunders, I can help clarify things a bit.

The crowdfunding world is the newest way to beg money from complete strangers online. Forget about the emails from the Nigerian Kings asking for money, come up with a business idea and make it legal. No one said you had to make a million dollars off the idea. How about designing and selling unique board games and profiting $80,000 a year? That’s a nice salary.

The crowdfunding world is a big world. Kickstarter, the world’s largest crowdfunding website, has received $4B in pledged money with over 150,000 successfully funded projects since it started in April 2009. Can you be a part of that? Yes, of course. The most successful Kickstarter project was for the Pebble Time, crowdfunding over $20 Million! Can you believe that?  I’d guess that most of the Fortune 500 Companies would call a $20 Million product launch a success!

What are the types of crowdfunding? In the academic world, there are actually 5 categories of crowdfunding: donations, equity, rewards-based, product presales, and peer-to-peer lending. You are probably more familiar with donation-based crowdfunding. That’s typically where the person asking for funds is asking for a donation and the funder (or donor) receives nothing back except maybe a feeling of goodwill. Gofundme.org is one of the main websites for donations. Examples may be when someone loses a house to a fire and needs money to replace items; or someone suffers a medical emergency and may need help paying the hospital bills; or a student wants to go on a mission trip and needs funding for travel costs.

Equity-based crowdfunding is the opposite of donation-based. Equity-based means that the funder receives a share of ownership in the company (or investment) in exchange for the money. This is like buying stock in a company. I’ve seen real estate investments that do this. However, they typically want people with big bucks, at least $5,000. Equity-based crowdfunding is not as common in the market as the other types. Companies or internet sites have to register with the SEC too since they are selling securities (ownership in the company).

Peer-to-peer lending is basically when a funder loans money to businesses or individuals, basically acting like a bank. The business can ask for a large amount of money, say $10,000 for a food truck. They will pay back the amount at a specified interest rate, making monthly payments. These websites are also required to be registered with the SEC. The most popular website is Kiva.org. This type of crowdfunding is not legal in all 50 states.

Now the product pre-sales and rewards based crowdfunding are the second most familiar types of crowdfunding to the masses. This is when an individual, entrepreneur, or business asks for money in exchange for a gift or product. In the case of product pre-sales, the business needs the money to manufacture the product. In essence, they are getting the money upfront, manufacture the product, and then send the finished product to the funder. These are the most popular types of crowdfunding for small businesses.

Those are the basic categories of crowdfunding. The differences are the internet platforms used, like Kickstarter or Kiva.org, the benefits that the funder receives, the rewards that the business or individuals gives, and of course, government regulation.

If you’re interested in crowdfunding for your business, subscribe to the blog as I’ll be continuing for the next few weeks on how small businesses can use crowdfunding to finance their business.

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