What is Crowdfunding

Startups and small businesses often find it difficult to access funds from traditional sources. They usually first pool their own savings, contributions from friends and family, before they consider taking a loan from a commercial institution. Some startups are research intensive while others are project-based like a concert. Institutional lenders are sometimes reluctant to fund such ventures or may extend limited amounts. Very often, in such cases business owners choose to fund their venture through crowdfunding.

In crowdfunding an entrepreneur uses an online platform to seek small amounts from a large pool of individuals. It is usually done by starting an online campaign which aims at raising a certain amount of funds, commonly referred to as the campaign target. The entrepreneur then promotes this campaign with the goal of reaching as many people as possible. People interested in the product start contributing money through the online payment gateway. The campaign will usually run for a certain time period. By the end of the timeframe for the campaign, if the campaign target amount is met or exceeds, then the campaign promoter receives the money raised through the campaign. The crowdfunding platform charges a small commission for managing the campaign. If the campaign target is not met, the money is returned to campaign backers. In some cases, depending on the terms of the campaign, the campaign promoter does not have to return the money but can keep whatever they have managed to collect.

In most cases, anyone could invest in a crowdfunding campaign. However, there are some industries such as real estate, where there may be some criteria as to who can invest.

Key Parties in Crowdfunding

Crowdfunding has 3 principal players. The sponsors, the platform and the investor.

  • The sponsor works with the asset, the investors are funding. They are the primary risk takers in the project and take an active role in its working.

  • The next player is the crowdfunding platform which enables the crowdfunding. They usually receive a percentage of the funds raised.

  • Investors constitute small individuals or high net worth individuals who choose to invest in a project through crowdfunding.

History of Crowdfunding

Crowdfunding originally started during World War II in which the U.S. government collected money from the people in small amounts for their war efforts. The well known and early example of crowdfunding was British rock band Marillion who raised USD$60,000 to bankroll their US tour. Film maker Mario Kives raised USD$125000 to complete his film Foreign Correspondents.

Starting from 2001, the number of crowdfunding platforms have steadily increased in the US, and we can see more and more countries starting their own platforms.

Crowdfunding: Pros and Cons

Crowdfunding is a financial decision that has pluses and minuses to it.

The big positives about crowdfunding are high user engagement, low communication costs,, large investor pool who are willing to contribute in lieu of interest, equity, rewards or a hybrid that involves two or more paybacks.

Crowdfunding attracts new investors. Campaign backers may be individuals who are interested in that particular sector. This is especially true of gaming and medical research start-ups. However, data from campaigns show that non-interest groups also participate often and that they contribute their voices to the process.

In traditional funding, communication mismatches and cost of marketing to attract investor attention can be prohibitively high. Thanks to the Internet and social media, startups can now share information at virtually no or a very low cost. This is one of the key reasons why online crowdfunding for business ventures and charitable causes are proving to be very popular and are helping close the fund-gap.

In the case of charitable crowdfunding the payback is usually the act of giving. In other types of products crowdfunding, the backer gets the chance to be involved in the process of development, share feedback in addition to a tangible monetary or material payback, and it is just as important.

If the crowdfunding campaign is a big success and there is high backer engagement and positive feedback for the business, it opens the doors to venture capital funding for entrepreneurs. Venture capitalists lookout for successful campaigns and view it as a proof of interest and concept. Crowdfunding, therefore, helps open the doors to other forms of funding for startups.

On the downside, negative feedback about a crowdfunding campaign lasts on the internet for posterity and is available to the public. If the startup does not deliver on the campaign promises, it will impede or stop any further crowdfunding campaigns the sponsor may have wanted to undertake.

Next, we will look at the various types of crowdfunding campaigns.

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