Crowdfunding : Meaning, Working, Types, Advantages and Disadvantages

What is Crowdfunding?

Crowdfunding is the practice of raising modest amounts of funds from a large number of people to fund a new business initiative. Crowdfunding takes advantage of the widespread availability of vast networks of people via social media and crowdfunding platforms in order to bring entrepreneurs and investors together, with the potential to boost entrepreneurship by broadening the pool of investors beyond the typical circle of owners, relatives, and venture capitalists. The money gathered through crowdfunding is often used to fund a specific project, make general donations, or rally support for a time-limited initiative. 

Geeky Takeaways:

• Crowdfunding allows businesses and individuals to raise funds from a large number of investors, who can choose among hundreds of projects for as little as ₹100.
• There are restrictions on who can fund a new firm and how much they can donate.
• Crowdfunding sites profit from a percentage of the funds raised.
• The SEC oversees equity-based crowdfunding operations in the United States.
• Kickstarter, Indiegogo, and GoFundMe are some of the most popular crowdfunding platforms.

How does Crowdfunding Work?

1. Acquiring and accumulating funds is important for any business to grow. It may be easier for bigger, more well-known companies to get money from investors or borrow more from their lenders. But there are things that some businesses may face that can stop their growth. This is very true for new and small businesses. Crowdfunding is helpful in these situations.

2. Entrepreneurs can now get hundreds of thousands or millions of dollars from anyone with money to spend thanks to crowdfunding.

3. It gives anyone with an idea a place to present it to investors who are ready.

4. The first time crowdfunding was used was by a music group from the UK in 1997, when fans helped them raise money for a concert trip. Three years after that, ArtistShare, the first site for donations, came out. After almost ten years, it became an important way for businesses to get money.

5. When crowdfunding sites first came out, they weren’t closely controlled. As time went on, though, things changed. Some types of donations became illegal in some countries, including the US. The people who can fund a new business and the amount they can give are limited by these rules.

6. Like the rules on investing in hedge funds, these rules are meant to keep investors who aren’t very smart or rich from risking too much of their savings. There is a high chance that buyers will lose their money because so many new businesses fail.

Types of Crowdfunding

The two most common meanings of the term refer to crowdfunding conducted by startup companies seeking to launch a product or service, as well as by individuals experiencing an emergency. Many people afflicted by a natural disaster, a large medical bill, or another catastrophic incident such as a house fire have gotten financial assistance that they would not have received otherwise, owing to crowdfunding services. However, in recent years, certain crowdfunding sites, such as Patreon and Substack, have broadened the scope of crowdsourcing to provide a means for creative persons, such as painters, writers, singers, and podcasters, to continue their creative activity by obtaining a consistent stream of revenue. There are four major types of crowdfunding: contribution, reward, equity, and debt crowdfunding.

1. Donation Crowdfunding: Donation crowdfunding is a campaign in which investors or donors do not receive a financial return. Individuals donate to support a specific idea or cause. Donation-based crowdfunding campaigns frequently raise funds for charities, organizations, and disaster relief operations. For example, a company may make philanthropic business donations to assist raise funds.

2. Reward Crowdfunding: Reward crowdfunding is when people contribute to a business in exchange for a reward or incentive. Typically, the incentive is something related to the product or service your company provides. Reward-based crowdfunding works most effectively for businesses that sell items and other tangible assets. It can also help startups find a test market for their product or service.

3. Equity Crowdfunding: Equity crowdfunding allows individuals to make real investments in private firms. Contributors might become part owners of your company by exchanging capital for equity shares. Basically, equity crowdfunding allows you to sell a portion of your company’s ownership to contributors. Your contributors receive a financial return on investment and a portion of earnings in the form of a distribution or dividend. Equity-based crowdfunding campaigns are popular among entrepreneurs and businesses seeking an alternative to venture capital investments.

4. Debt Crowdfunding: In debt-based crowdfunding, the campaign creator borrows money from contributors. People agree to lend money to a corporation. In exchange, firms promise to repay loans. Typically, business owners establish time limits for how long it will take to repay contributions, including interest rates. Entrepreneurs who do not want to give up stock in their business may seek assistance from debt crowdfunding instead.

Advantages of Crowdfunding

1. Access to Capital: Crowdfunding allows individuals to obtain investment without the involvement of traditional financial institutions or venture capitalists. This is especially useful for startups and small enterprises that may struggle to obtain capital through traditional channels.

2. Market Support: A successful crowdfunding campaign can provide support for your idea or product. If others are prepared to invest in or support your project, it means there is a market demand for it.

3. Early Adopter Participation: Crowdfunding allows creators to connect with early adopters and enthusiasts directly. These backers can contribute valuable feedback and insights that will help enhance the product before it is released to a larger public.

4. Marketing and Advertising: Crowdfunding projects can generate tremendous buzz and media coverage, giving you access to a wide audience. This exposure might help to increase awareness of your project and attract potential consumers or investors.

5. No Ownership Dilution: Unlike conventional fundraising strategies such as venture financing, crowdfunding usually does not include giving up equity in your firm. This enables artists to maintain complete ownership and control over their products.

6. Large Funding Sources: Crowdfunding allows creators to connect with a broad group of backers from all around the world. This diversity can assist reduce the risk of relying on a single source of support.

Disadvantages of Crowdfunding

1. Massive Competition: Crowdfunding platforms have grown more crowded, making it difficult to stand out amongst the thousands of campaigns released each day. This high degree of competition can make it harder to recruit investors and meet financial targets.

2. Time and Commitment: Running a successful crowdfunding campaign takes a great amount of time and effort. To assure success, creators must invest significant resources in everything from strategy and preparation to campaign promotion and backer communications management.

3. Uncertain Results: Despite meticulous planning and preparation, there is no assurance of success with crowdfunding. Even well-conceived projects may fail to garner enough backers or funds to achieve their objectives, leaving creators empty-handed.

4. Service Fees: Most crowdfunding sites charge fees to host campaigns and process donations. These costs might deplete the funds raised, limiting the total amount available to the developer.

5. Risk of Overpromising: In order to attract funders, creators may overpromise on what they can achieve, creating excessive expectations and potential disappointment if the project fails to meet its objectives.

6. Intellectual Property Risks: When artists share ideas and prototypes publicly during a crowdfunding campaign, they risk having their intellectual property stolen. Without sufficient protections, competitors or unscrupulous persons may steal or reproduce the concept before the originator has a chance to market it.

Examples of Crowdfunding

Many of the goods and businesses crowdfunded on Kickstarter became extremely successful and profitable ventures. For example, Oculus VR, an American firm that specializes in virtual reality technology and software, received funding through the site. Palmer Luckey, the company’s founder, started a Kickstarter campaign in 2012 to generate funds for developers to use virtual reality headgear developed for video gaming. The campaign raised $2.4 million, ten times its initial goal of $250,000. Meta (META) acquired Oculus VR in March 2014 for $2.3 billion in cash and stock. M3D, a company formed by two friends that manufacture small 3D printers, is another example of a firm that climbed to success thanks to Kickstarter crowdfunding efforts. In 2014, David Jones and Michael Armani raised $3.4 million for their Micro 3D printer through crowdfunding. The compact 3D printer, which includes a choice of long-lasting 3D inks, is currently available at Staples, Amazon (AMZN), Brookstone, and other retailers. In April 2019, Critical Role, a monthly live-streamed tabletop roleplaying game starring a collection of notable voice actors, earned $4.7 million in just 24 hours for its next animated special, “The Legend of Vox Machina.” No other Kickstarter campaign in 2019 raised as much money over the course of 30 to 60 days.

Popular Crowdfunding Websites

Crowdfunding platforms like Kickstarter, Indiegogo, and GoFundMe draw hundreds of thousands of people looking to start or support the next great thing.

GoFundMe	GoFundMe is the largest crowdsourcing platform. GoFundMe, which was started in 2010, has raised more than $25 billion from over 200 million donors. GoFundMe is the most popular website for those trying to recover from a medical bill or calamity, such as a house fire, natural disaster, or unforeseen emergency expense. Kickstarter is commonly used by start-up companies.
Kickstarter	Kickstarter is another popular option. Founded in 2009, the platform has successfully funded about 250,000 projects, totaling more than $7.6 billion donated across all Kickstarter projects. Kickstarter is the most popular crowdfunding platform for entrepreneurs looking to generate funds and reach a broader audience. In reality, unlike GoFundMe, Kickstarter is limited to producing projects that may be shared with others. Kickstarter prohibits raising funds for charity or causes, offering incentives like equity, revenue sharing, or investment opportunities, and involving prohibited items like “any item claiming to diagnose, cure, treat, or prevent an illness or condition,” political fundraising, drugs or alcohol, contests, coupons, gambling, and raffles.
Indiegogo	Indiegogo began as a crowdsourcing platform for indie films but later expanded to welcome projects from all categories. Indiegogo is seen as a less stringent and more flexible platform than Kickstarter since it allows backers to choose whether they want fixed or flexible models—this is perhaps the most significant distinction between the two crowdfunding platforms. Kickstarter only releases funds after the campaign has attained its funding goal, whereas Indiegogo allows the campaigner to get funding pro-rata or wait until the target has been met.

As a campaigner, it may be easier and less hazardous to pursue flexible funding, such as getting donations as they arrive. However, regardless of the amount raised, campaigns must follow through on any promises made. Fixed funding is more appealing to backers since it carries far less risk.

Frequently Asked Questions (FAQs)

1. What is crowdfunding?

Answer:

Crowdfunding is a means of obtaining finances for a project, venture, or cause by seeking modest contributions from a large number of people, usually using an internet platform.

2. How does crowdfunding work?

Answer:

Creators or project owners create a campaign on a crowdfunding site to outline their idea, financing goals, and rewards for backers. Individuals who wish to assist the initiative may do so in exchange for prizes, equity, or simply by donating to the cause.

3. What are the different sorts of crowdfunding?

Answer:

Crowdfunding can be reward-based (where backers receive non-financial rewards), donation-based (where backers contribute without receiving rewards), equity crowdfunding (where backers invest for equity shares), or debt crowdfunding (where backers lend money with interest).

4. Is crowdfunding just for startups?

Answer:

No, crowdfunding may be utilised by a wide range of people and organisations, including businesses, artists, non-profits, and community groups. It is a flexible funding approach that may be used for a variety of initiatives and ventures.

5. Are there risks associated with crowdfunding?

Answer:

Yes, crowdfunding, like any other investment or fundraising strategy, involves risks. Projects may fail to meet their financial targets, execute on promises, or gain success after funding. Before contributing, backers should undertake due diligence and understand the potential dangers.