The Right Tool to Start Your Business?

Crowdfunding is a financing method that involves funding a project with small contributions from a large group of individuals. It offers a flip-side alternative to venture capital, which typically involves seeking large sums of money from a small number of investors.

The funding campaign and transactions for crowdfunding are typically conducted online through dedicated websites, usually in conjunction with electronic social networking. Typically a campaign consists of a certain number of days to achieve a particular fundraising target. Once a project is launched, each day will be counted down and the money raised will be tallied up for visitors to follow its progress.

Following the passage of the U.S.’ Jumpstart Our Business Startups (JOBS) Act in 2012, which eased regulations, making it easier to start small businesses, enterprises developed with crowdfunding have proliferated throughout the United States and the trend has started to catch on in other countries.

Depending on the project, contributors can make donations, invest for a potential future return on investment (ROI), or prepay for a product or service. These three types of crowdfunding models are known as contribution/donation, debt, and equity respectively.

Contribution/donation is funding raised online where contributors receive non-monetary perks for helping fund and grow a business. Many entrepreneurs use this model to finalize, test and launch new consumer products. With debt financing, supporters are repaid with interest on an established schedule with specific terms. In this model, supporters do not receive ownership in the business. The debt crowdfunding model is typically used by businesses with solid revenues and assets. The equity model is used by established small businesses with growth data that offer equity shares in return for investment; supporters become shareholders.

The success of a crowdfunding campaign relies upon the ability to drum up support from a large group of potential contributors. The goal is the same as any other fundraising campaigns: to convince enough people to contribute in order to reach a target figure.

Sites such as Kickstarter, GoFundMe, and RocketHub have emerged as platforms for consumers to ask for or donate money for projects. In Canada, Fundrazr is the most visited site for crowdfunding. Other notable sites include Foodstart (a restaurant and food truck funding site) and We Did It, a crowdfunding site for nonprofits.

Anyone looking to finance their project in this way needs to have an understanding of the commitment, strategy and time the process requires. Keeping up the momentum of a campaign and being communicative with investors is necessary to ensure a project has good publicity and reaches its goal. Prior planning and creating a “buzz” about a product are also crucial to the success of a campaign. Fundraisers must find potential customers and may have to court them for several months before initiating a pitch. Such a strategy can entice potential investors and make them excited about a campaign.

Crowdfunding campaigns need to create a compelling message to convince people to donate money. Individuals can craft a vision by having a short video, an introduction to the project, or even some images to demonstrate the overall concept of a given project. Having enough people who connect and resonate with the purpose of a campaign can determine whether or not a crowdfunding project will succeed or fail.

When a crowdfunding fundraiser concludes, several things can happen. If the fundraiser was unsuccessful in reaching its target goal, the funds are typically returned to backers. However, some crowdfunding websites still allow companies to collect all the money raised even if they fail to reach their goal, though usually for an additional fee.

If a fundraiser is successful, the entrepreneurial company, organization or individual receives the total amount of the money raised, minus any processing fees. These processing fees are only required for successful crowdfunding projects and are not charged to any that do not reach their target goal amount.

According to an article from USA Today, crowdfunding websites raised an estimated $2.8 billion in 2012. Kickstarter recently released data that further demonstrates the power and impact of crowdfunding: in 2012, they reported that 2 241 475 people pledged a total of $319 786 629 to successfully fund 18 109 projects on their platform alone. Additionally, more than $300 million worldwide was contributed for a wide range of projects and seventeen of those projects each raised more than $1 million. Canadian filmmaker Amber Fares launched a crowdfunding campaign on Indiegogo to fund her movie Speed Sisters: Racing in Palestine and raised $46 000.

One of the most noteworthy crowdfunding campaigns has been the campaign to raise money to develop a smartwatch for Pebble Technology. After failing to attract traditional investors to finance the smartwatch, product developer Eric Migicovsky launched a campaign on Kickstarter in April 2012 to raise $100 000. In a little over a month, the campaign raised over $10 million. Although an extreme example, the fundraising for this product gives an idea of the power that crowdfunding can have to raise money for a compelling project.

Crowdfunding is not only used to start businesses, but can also be used to benefit the nonprofit sector. One of the most notable examples has been The One Fund Boston, which was a campaign developed by Massachusetts Governor Deval Patrick and Boston Mayor Thomas Menino to raise funds for the victims of the Boston Marathon bombing attacks in April, 2013. To date, the campaign has raised $31 million, almost half of it donated by the public while the rest of the money was gleaned from corporate donors.

As with any type of investing, there are risks involved with crowdfunding. With its collaborative nature, the individual or organization raising money becomes accountable to all the hundreds or thousands of people that support their project. The story of Los Angeles designer Seth Quest who invented a stand for iPads called the Hanfree is a well-known cautionary tale in the world of crowdfunding.

In May 2011, Quest successfully raised $35 000 on a crowdfunding site, far exceeding his initial goal of $15 000. However, after several months without communicating to his investors about product developments, supporters used the campaign’s forum to openly complain about not receiving a return on their investment. After Quest admitted that the product was going to cost more money than he initially anticipated, he promised to provide his backers with refunds. When investors didn’t get their money back, an attorney from Arizona who invested in the project filed a class-action lawsuit and Quest wound up filing for bankruptcy. Many experts cite the lack of transparency and communication after the campaign as a mistake that can be easily avoided by future prospective crowdfunders.

Cases of fraud or unregulated charities looking to fund their projects have also been known to occur, but many of these problems are revealed in the message boards and forums of crowdfunding sites. Nonetheless, there remains an ongoing question with respect to what kind of regulation or control of crowdfunding might be seen in the future.

Still today, crowdfunding can prove a great asset for entrepreneurs, nonprofit managers, and individuals looking for funds to bankroll their businesses, projects and campaigns. This phenomenon demonstrates a paradigm shift in how people raise funds and awareness about the issues and projects close to their hearts. As more crowdfunding campaigns develop and the process evolves, people will be able to look to this era of innovation for lessons and inspiration for how to turn their dreams into reality.

May 25, 2020, 4:37 PM EDT