If you believe what they say on the internet, everyone is doing so much “crowd funding,” they’ve decided to make it just one word: crowdfunding. Unfortunately, like many things said on the internet, the word crowdfunding can mean so many different things to different people in different situations; it can mean just about anything. That’s why we’ve decided to create some guides on different topics related to crowdfunding. In addition to this introduction, in later guides, we’ll be going into greater detail on crowdfunding topics, platforms and strategies.
What is crowdfunding?
(Crowdfunding, n. The practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.)
In high school, you were probably forced to read his famous satire, Gulliver’s Travels, but you probably didn’t make the connection between crowdfunding and Jonathan Swift. In a lot of ways, Swift was the founding father of modern crowdfunding. Believing that the lower classes in Ireland would benefit greatly from microlending (or microfinancing), he helped set up the Irish Loan Fund, which dispersed small loans to individuals who lack credit experience and collateral, but could still be deemed “creditworthy.” The program was so successful that, by the 1800s, there were more than 300 microfinancing organizations throughout Ireland.
Microfinance continued to evolve through the nineteenth and twentieth centuries, eventually taking to the Internet with Kiva.org in 2005, but didn’t morph into the “crowdfunding” we know of today until 2009 when Kickstarter and other currently popular crowdfunding internet sites launched. Since then, the movement has exploded, with crowdfunding platforms providing $5.1 billion worth of support worldwide in 2013 (up from $2.7 billion in 2012 and $1.5 billion in 2011), according to Crowdmapped.com.
The three types of business-related crowdfunding
(Photo: On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups (JOBS) Act, enabling equity crowdfunding. Via: White House)
Crowdfunding, in one way or another, has been around since the earliest days of online communities. However, in most early instances, the funding had to do with raising donations for everything from walk-a-thons to helping individuals with medical or legal funds.
The success of the crowdfunding platform Kickstarter has greatly raised the visibility and possibility of business-related crowdfunding. But even Kickstarter started primarily as a venture for creative pursuits: artists and musicians raising money to finish projects. It has since grown into a system that also supports the development of products by craft makers, inventors and small businesses of all kinds. More recently, crowdfunding has become a means to raise equity capital with the passing of the JOBS Act in 2012. (We’ll explain in a moment.)
Here are three ways businesses typical crowdfund today:
1. Donation- and Reward-based crowdfunding: also known as “Project Backing”
Reward-based crowdfunding is largely used by musicians, filmmakers, inventors, free software developers, scientists and individuals looking to take on civic or social entrepreneurship projects. It usually follows one of two approaches:
- All-Or-Nothing (AON), which means only keeping the funds if the goal is met.
- Keep-It-All (KIA). hich entails keeping the funds no matter if the goal is met or not.
Reward-based crowdfunding, using the Kickstarter model, usually grants contributors a reward based upon how much money they give. A filmmaker, for example, may offer a free DVD for a $20 donation, a free DVD and t-shirt for a $40 donation, a VIP ticket to the premiere for $60, and a role as extra in the film AND a VIP ticket to the premiere for $100 and up. In other words, the public-broadcasting approach.
2) Credit-based crowdfunding
This essentially goes back to Jonathan Swift and his microcrediting efforts. But instead of receiving a small loan from one program or bank, crowd-based credit allows individuals and businesses to receive a series of small loans from a large group. Sites like LendingClub.com and Prosper.com are major hubs for those interested in credit-based crowdfunding.
3) Equity-based crowdfunding
Ok, here’s where it gets tricky. While at its base level, equity crowdfunding is easy to understand—investors provide money for a piece of your company—it’s not that simple. Thanks to the passing of the Jumpstart Our Business Startups (JOBS) Act in 2012, and the IPOnet, SEC Letter issued in 1996, there are three types of equity-based crowdfunding:
- Equity I. This allows an unlimited number of accredited investors to see private opportunities on password-protected websites. Equity I crowdfunding is best suited for companies who are looking to keep their fundraising campaigns private.
- Equity II. Thanks to Title II of the JOBS Act, entrepreneurs also have the option of publicly advertising investment opportunities to an unlimited number of accredited investors. AngelList, Crowdfunder and Early Shares are popular sites for businesses and individuals looking for equity-based crowdfudning.
- Equity III. This allows for anyone—accredited or not—to invest money in a company, product or project in return for equity. At the time of writing, Equity III crowdfunding is not yet legal in the US. It was included in Title III of the JOBS Act, but is still waiting approval. Most believe it will be legalized by the end of 2014.
Is it right for you?
(Photo: Yancey Strickler, co-founder of Kickstarter. Photo via Rex Hammock, SmallBusiness.com)
Crowdfunding is alluring. Pre-selling your product before manufacturing? What’s not to like about that? Raising equity without having to deal with traditional banks or investors? Sounds awesome. But before you get too ahead of yourself, you should consider a few things. Most importantly: Nothing is as easy as it sounds. Not every business or product is right for crowdfunding. And most projects fail. For every story you hear about a guy raising $50,000 for a bowl of potato salad, there are dozens of incredibly creative ideas that fail.
According to Crowdfund Insider, as of August 2013, Kickstarter campaigns have had a 44% success rate, and Indiegogo a meager 10% success rate. Meaning that there’s a stark difference between ideas or businesses that are right for crowdfunding and those that aren’t. But how do you know whether yours belongs to the “right for crowdfunding” or “stick to traditional ways of raising money” sets.
Ask yourself these questions:
- Is the crowdfunding world oversaturated with your product/project? Remember: There are a lot of businesses seeking financing from the masses. This means there are probably businesses/products/projects like yours already receiving funding. You simply need to do some research and find out how saturated the market is with products/projects like yours. Investors want unique; so make sure you’re giving it to them.
- How good is your story? Think of it this way: Monetary investment is much more likely when there’s emotional investment. Just like we’re drawn to movies that are “based on true story,” products or projects that carry a powerful, inspiring and/or engaging narrative behind them have a better chance of succeeding.
- Do you have a clear message and realistic goals? As Crowdfund Insider points out, “Unclear goals and a lack of concrete objectives are a death knell,” for small businesses seeking funding. So be specific and concise when describing who you are and what you do, and what you hope to achieve. Also be fair with your expectations. Everyone has huge aspirations with their business; don’t get carried away in the dream.
- Do you have a good system behind you, including a team and social media support? Look at the people around you. Your brand is more likely to be supported if you show it’s got a group of like-minded and equally passionate individuals behind it. It also helps to have a decent (and loyal) following on social media—aka people you can reach out to when selling/promoting.
Notable crowdfunding platforms
Worldwide, there are over 500 crowdfunding platforms. In the U.S., a sampling of platforms are:
- Kickstarter: The 800 lb. platform for business-related reward crowdfunding. In March, 2014, it passed $1 billion in donations to projects.
- Indiegogo. While Kickstarter specializes in donation-based crowdfunding for creative pursuits, Indiegogo allows it for anything—business, personal, creative.
- Crowdfunder:. Equity-based crowdfunding that claims to have the largest network of accredited investors.
- Crowdrise: A donation-based crowdfunding site for non-profits, causes and charities.
- Lending Club: One of the oldest and most successful credit-based crowdfunding sites.
- Invested.in: A “white label” platform that allows you to create your own crowdfunding feature on your own website.
- The Ultimate Crowdfunding Guide
- The Kickstarter Creator Handbook
- The Indiegogo Playbook
- RocketHub Success School
- The Crowdfunding Bible (pdf)
Note: As with any decision regarding finance or money, always consult your personal financial and legal advisors before making any decisions. Crowdfunding should not be entered into without plenty of research and consideration.
(Featured Photo: Pablo Manriquez via Flick)