With hundreds of crowdfunding platforms around the world and billions of dollars being raised every year, crowdfunding has become a popular option for entrepreneurs to raise funds, gather momentum, and engage with the public. If you’re an entrepreneur who is new to this fundraising option, keep reading to learn about the basics of crowdfunding and recent changes made to crowdfunding regulations.
What is Crowdfunding?
Crowdfunding is the practice of raising small amounts of capital for a cause, project, or business venture from a large group of people. It can be as simple as gathering contributions from family, friends, and acquaintances, but most entrepreneurs choose to launch campaigns on social media or on crowdfunding platforms in order to access a wider network of potential backers.
Why Run a Crowdfunding Campaign?
Crowdfunding has several advantages over the traditional approach of pitching to investors. It is comparatively easy to implement, bears a lower risk, and can have a far-reaching impact.
Crowdfunding allows you present your product or service in a streamlined format (typically a webpage) that is accessible to all. Crowdfunding platforms such as Kickstarter or Indiegogo are popular because they allow businesses to publish information about the project, post updates, engage with potential investors or customers on social media, and keep track of financial goals.
The experience of crowdfunding can also help if you require another round of funding down the road and need to turn to other forms of investment, such as venture capital or a bank. A good crowdfunding campaign condenses information so it’s easy for potential backers to understand, which will help you with your business pitch. What’s more, running a crowdfunding campaign gives you the opportunity to collect useful feedback from potential customers and make improvements before you launch. A successful crowdfunding campaign validates your idea and shows market readiness. Should you need more capital down the line, investors may look at your fundraising campaign as proof of concept.
What are the Types of Crowdfunding?
There are four main types of crowdfunding:
1. Rewards-Based Crowdfunding
A rewards-based campaign incentivizes backers with a reward, such as a discounted product or a branded good. Backers usually contribute small amounts (between $1 and $1000), and their rewards can be scaled according to how much they give. For example, a backer who pledges $15 to a book project receives a digital copy, while pledging $30 gets a hardcover copy. This popular form of crowdfunding works best for consumer products and creative projects.
2. Debt-Based Crowdfunding
In debt crowdfunding, backers lend money to the company with the expectation of being repaid the principal plus interest. This model is usually used by companies that are already operational (as opposed to startups) because they have cash flow and can likely shoulder some debt.
3. Equity-based Crowdfunding
In this model, contributors provide larger sums in exchange for part ownership, or equity, in the company. Equity crowdfunding is usually used by companies seeking higher sums (over $50K) in order to fund their launch or support their growth.
4. Donation-Based Crowdfunding
In this type of crowdfunding, contributors make a donation to the campaign with no expectation of a reward or equity. Startups do not typically use this model, as most people prefer donating to a charity or nonprofit organization over a business. Donation-based crowdfunding is largely used to raise money for charitable projects, disaster relief, and political campaigns.
Why Do I Keep Hearing About Equity Crowdfunding?
You might be hearing more about equity-based crowdfunding right now because it only recently became accessible to the average person. Title III of the JOBS Act was part of a largescale federal campaign to spur the growth of small businesses and removed restrictions on who could invest in private companies.
Before May 2016, only accredited investors (those with an annual income of at least $200,000 or with a net worth exceeding $1 million) could invest. Now, despite some limits for those whose income falls below $100K, anyone can purchase equity in a company through crowdfunding.
In the few months that equity crowdfunding has been in effect, investors across the country have participated in campaigns. So far, the equity crowdfunding campaigns have experienced a good success rate, with more than a quarter of them meeting their funding targets. To compare, rewards-based campaigns meet their target less than a third of the time (success rates vary depending on the platform used, with Kickstarter having the highest number of successful campaigns).
How do I Run a Successful Crowdfunding Campaign?
There is no shortage of tips out there to help you run a successful campaign, but businesses that experience success are typically good storytellers, can tap into a large social media following, and offer attractive rewards to their backers.
Be sure to present your business plan in a visually compelling way and communicate clearly about how the money will be used. It’s also a good idea to post regular updates about the campaign or the product on your page, and to keep your supporters informed with a newsletter or personalized email.
When it comes to equity crowdfunding, there’s no clear roadmap to success, but there are some tips that can help you to start your campaign off on the right foot. As equity crowdfunding is government regulated, it is vital to follow SEC guidelines:
- Investors can only buy into a company whose campaign is run on a FINRA-approved crowdfunding platform, so be sure to consult the list of approved portals and fill out the appropriate paperwork before launching your campaign.
- Verify whether your state has regulations surrounding equity crowdfunding so that you remain compliant with local laws.
- Be clear with investors about the terms of exchange, including how you reached your valuation, how equity may fluctuate, and shareholders’ rights should there be additional rounds of financing.
- Communicate how you intend to use the funds as SEC regulations regarding equity crowdfunding prohibit business plans that revolve around a merger or acquisition.
- Ensure your marketing and advertising campaigns comply with SEC regulations, which specify what can and cannot be included in an advertisement.
Tapping into the Crowd
Crowdfunding gives startups, small businesses, and creative projects an alternative to bank loans and venture capital, and allows them to tap into a vast network of backers. The downside? The crowdfunding space is becoming increasingly competitive. To run a successful campaign, entrepreneurs have to dig deep and determine how to stand out in the crowd. Focus on the unique aspects of your product so that potential investors can see just how innovative your idea is.
Have you ever supported a business through crowdfunding?