What is crowdfunding? How does it work?

Crowdfunding is a system of raising money for a project or venture by asking lots of people to each contribute a small amount of money, i.e. you try to get a ‘crowd’ to ‘fund’ you. This is typically done online.

In the past, getting funding for a venture, project or business meant asking a few individuals or firms for large sums of money. Crowdfunding turns the idea back-to-front: few individuals become many, and large sums of money (each) become small sums.

If you are seeking funds, you set up a profile of your project on a crowdfunding-dedicated website. Visitors look at your idea or proposal and decide whether or not to contribute.

CrowdfundingCrowdfunding involves a large number of people with each contribute a small amount of money.

Even though the term is relatively new, the actual concept of crowdfunding has been around for a while. The Statue of Liberty was funded by many individuals who contributed a small amount each.

The term was first coined in 2006 by Michael Sullivan. Sullivan attempted to create a medium for people with videoblog-related projects to receive funding. However, the term ‘crowdfunding’ didn’t really kick off until the Kickstarter platform came onto the scene in 2009.



 

There have been various other media for receiving funding via the internet long before Kickstarter. An example of such a platform is ArtistShare, which was launched in 2003, and in 2005 was described as a “completely new business model for creative artists” that “benefits both the artist and the fans by financing new and original artistic projects while building a strong and loyal fan base”.

Other online platforms that essentially used crowdfunding before Kickstarter, include: ChipIn (2005), EquityNet (2005), Pledgie (2006), Sellaband (2006), IndieGoGo (2008), and GiveForward (2008).

There are two main participants in the crowdfunding model:

– the people proposing an idea/project, and

– the people who support the proposals.

These two participants are able to group up via an online platform (website).

Example of a Crowdfunding platform (GoFundMe.com)

This is a screenshot of GoFundMe.com's homepage, highlighting how these online platforms work

As you can see in the picture above, not all crowdfunding is carried out for business purposes. In fact, many people use crowdfunding as a means of raising funds for charity or personal purposes. 

The four main types of crowdfunding

There are four main types of crowdfunding that differ based on how the people “backing” the project are rewarded, these are:

Donation-based crowdfunding: the backers make donations in support of a cause but there is no financial return for them. An example would be a family asking for money to help keep up with cancer treatment costs.

Reward-based crowdfunding: the backers make donations in support of a project in exchange for a “reward”, which typically has clear monetary value.

Credit-based crowdfunding: the backers make contributions in the form of a credit loan and receive interest payments.

Equity-based crowdfunding: the backers make contributions and receive shares of a company in return.


The video below, created by www.crowdfundingplanning.comhighlights what crowdfunding is and the different types of crowdfunding that exist:


The pros of crowdfunding:

  • Access to capital and a means of funding a venture without going into debt or losing equity.
  • Gain market validation.
  • Boosting a producer’s profile and presence.
  • Encourages people to spread word about the campaign.
  • Allows good ideas to be recognized and flourish.
  • Audience engagement and feedback.
  • Attention from media outlets.

The cons of crowdfunding:

  • If the public reaction is negative it can have a long-lasting negative impact on the project.
  • There is a risk of idea theft by publishing a project idea online.

The risks of crowdfunding

Crowdfunding can be a a brilliant means of generating funds for a project or idea.

As a result, there are a number of online crowdfunding platforms that are currently flourishing.

However, what are the risks involved in crowdfunding? Are there any pitfalls?

Yes. Public disclosure of intellectual property can undermine its legal status. If a project/idea is submitted online for other people to view, you are at risk of losing the ability to complete a patent application.

Under the US Patent Act, if patentable technology is publicly disclosed for more than a year, then a patent cannot be filed.

List of crowdfunding platforms:

Platform Locations Notes
Indiegogo Worldwide Platform is available to anyone, anywhere, to raise money for anything.
RocketHub Worldwide If the funding target is not reached by deadline, the project leader can still keep the collected funds.
Peerbackers Worldwide Known for including young entrepreneurs.
Kickstarter US, UK, Canada Focuses on creative endeavors.
GoFundMe Worldwide Well known for personal-cause crowdfunding.