Crowdfunding Definition: 4 Types of Crowdfunding

Crowdfunding—a combination of “crowdsourcing” and “funding”—is the practice of raising capital for a cause or business venture by asking a large number of people to make small donations. Online fundraising platforms, which charge various processing fees, host crowdfunding campaigns. Once the campaign is live on the web, the fundraiser promotes the crowdfunding project to friends, family, and the public via email, text message, and social media.

Modern-day crowdfunding began in 1997 when a British rock band successfully funded a tour through online donations from fans. But it wasn’t until the early 2000s that the term “crowdfunding” became popular.

In 2012, the United States signed into law the Jumpstart Our Business Startups Act—also known as the jobs act or the crowdfunding bill. The act legalized equity crowdfunding and made it easier for entrepreneurs to publicly raise capital. In tandem, the law requires all US-based crowdfunding websites to register with the Securities and Exchange Commission (SEC).

There are four common types of online crowdfunding, each with its own stipulations.

1. 1. Donation-based crowdfunding: This is the most common type of crowdfunding. Individuals donate (typically small amounts of money) to a cause or effort without expecting anything in return. Donation-based crowdfunding doesn’t require the fundraiser to pay funders back.
2. 2. Equity-based crowdfunding: This type of crowdfunding generates capital for small businesses or early-stage startups. Equity crowdfunding asks individuals to invest money in return for a small amount of equity in the company. Terms of these agreements vary—and might require the fundraiser to pay back its donors at a later date. For those new to entrepreneurship, equity crowdfunding is a great alternative to finding accredited investors or angel investors, or securing venture capital funding.
3. 3. Rewards-based crowdfunding: Small businesses, startups, and nonprofits commonly use this type of fundraising campaign. Rewards-based crowdfunding often uses a tier-based donation system, meaning the fundraiser will provide backers with a reward—like a service or new product—in exchange for a predetermined contribution amount. Rewards-based crowdfunding doesn’t require the fundraiser to pay funders back.
4. 4. Debt-based crowdfunding: This type of crowdfunding, also referred to as peer-to-peer lending, requires borrowers to repay their investors by a predetermined time. Funds raised might be subject to interest rates depending on the contract signed by both parties.

Equity crowdfunding and venture capital funding are similar because founders exchange equity in their company for money. The similarities stop there. In a typical scenario, equity crowdfunding only gives away non-voting, common shares to investors. This ensures the business owners retain control over the company. Equity crowdfunding also allows for an infinite number of investors, unlike venture capital funding, which is a deal between a small business or startup and one venture capitalist or venture capitalist firm for a large amount of money.

If you’re looking to raise money through a crowdfunding campaign, consider following these six steps:

1. 1. Choose your platform. Different crowdfunding platforms serve different purposes. Certain online platforms require you to reach your predetermined financial goal within a specific timeframe to receive funding. Meanwhile, other platforms allow you to keep any donations you raise without meeting a goal.
2. 2. Set a reasonable goal. Before launching a crowdfunding campaign, consider the minimum amount of funding you will need to launch your business, pay off debt, etc. Once you establish that number, share your plans for the money on your project page.
3. 3. Determine the length of the campaign. Creating a short-term campaign can be a good way to generate excitement and urgency among potential donors. However, if your campaign’s time frame is too brief, you might not have time to spread the word about your crowdfunding project to a large group of people. If the campaign lasts too long, your fundraising efforts could experience a drop in momentum.
4. 4. Create a solid pitch. One of the best ways to foster a successful crowdfunding campaign is by making a short pitch video explaining why people should donate money to your project. Passion, clear communication, and brevity are the keys to creating a pitch video that resonates with donors. Keep your pitch under five minutes. Try to connect with your target audience on an emotional level to express the importance of your fundraiser.
5. 5. Offer special incentives. If you’re launching a campaign on a rewards-based crowdfunding platform, create special incentives that will appeal to potential donors. For example, an indie filmmaker might offer an exclusive visit to the movie set as an investor incentive. These rewards can foster excitement for your project and encourage potential donors to become a part of your campaign.
6. 6. Promote heavily. To make crowdfunding work for you, you must spread the word. The best ways to share crowdfunding campaigns with the masses are via social media, email, and text message. Sending out a monthly e-newsletter is also a great way to update your network about your campaign.

There are several benefits of crowdfunding. Low financial risk is at the top of the list. Aside from making an enticing pitch video, there is little to no financial burden associated with a crowdfunding campaign. Additionally, a successful campaign has the potential to validate your business idea and convey to the public that it’s a worthwhile investment. A crowdfunding campaign also has the potential to go viral. This could result in an influx of donations as well as increased brand recognition.

There are a few downsides to consider before launching a crowdfunding campaign. There’s a chance that your campaign won’t succeed, which might result in a failed business venture due to unraised capital or the concept being poorly received by the public. Unless a copyright is protecting your idea, there’s also the risk that someone might claim your idea as their own after stumbling across your crowdfunding page. Additionally, it’s important to keep in mind that crowdfunding sites charge credit card and other platform fees in exchange for hosting your project.

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