What is Crowdfunding & How Does It Work?

Crowdfunding is a way to raise capital from the collective effort of your friends, family, individuals, and accredited investors.

It’s a young and growing market which brings together individuals who are willing to commit money in projects and companies they are interested in.

This is a great opportunity for businesses that aren’t qualified enough to get traditional financing such as bank loans, and SBA loans.

In a way you could say crowdfunding is a combination of crowdsourcing and microfinance, since it enables startups and small businesses to raise capital from the collective effort of a large number of individuals primarily via social media and crowdfunding platforms.

You can leverage those platforms to get more reach and exposure to your crowdfunding campaigns.

How is crowdfunding any different from the rest?

Traditionally, if you wanted to raise capital for your new or existing business, you would have to pack up your laptop, business plan, marketing plan, and even a prototype of your new product, and then shop your idea to the limited number of wealthy individuals and institutions you are familiar with.

It’s very hard to secure funds from traditional finance sources such as banks, microlenders, angel investors, and venture capitalist firms, since they expect your business to already be generating a decent amount of profit.

Crowdfunding on the other hand gives you a platform to create, showcase and share your business plan, financial requirements, and future milestones with millions of individuals who are willing to invest money in your campaign either expecting something in return or as a gesture of support.

As you can see, crowdfunding makes it easier to get your business idea in front of individuals and investors, and gives them the flexibility to invest as little or as much as they want for your cause.

What are the benefits of crowdfunding?

• Reach & exposure

Platforms like Fundable and Kickstarter will give you access to millions of potential investors and donors who are likely to interact with, and share your campaign on their social media, thereby getting you even more exposure.

• Presentation

Observe and read through some of the most successful campaigns out there. You will start to understand “why” people invested money in them, “which” areas you need to cover and “how”.

If you want to create a successful campaign, you need to cover areas such as history, traction, market growth, target audience, unique value proposition, and etc.

So not only will crowdfunding gives you the opportunity to raise capital but also helps you prepare yourself when its time to turn towards other means of financing.

• You can use social media

You can use social media to leverage your friends and family to contribute to your project or startup. Also, if you have a LinkedIn account with a decent amount of connections, you may be able to find some potential investors then and there itself.

• You can get valuable feedback

No offense but the majority of investors are likely to be more knowledgeable about businesses than you. They will be able to tell what’s wrong or missing in your business plan, market research, or the product itself.

When they take an interest in your campaign they may ask questions that you may not have even thought about. That way you can identify what’s missing in your plan or product, and refine them accordingly.

• Efficiency

Crowdfunding makes your fund raising efforts more streamlined and efficient since you can funnel prospects and potential investors to one single campaign, and get them to invest online.

This eliminates the need to spend time and money printing, binding, and updating paper documents every time you update your plan.

What are the drawbacks of crowdfunding?

• It’s easy to exhaust your social media

If you have multiple campaigns and if you rely on your social media connections, avoid spamming the social walls of your friends and family.

• You need to invest some time and money

If you want people to take your campaign seriously and build enough trust to actually invest in it, you need to spend time and money creating a beautiful front page with a compelling video.

If you know video editing and graphic designing you could probably put together a nice video and some colorful infographics all by yourself but if not, you would need to hire someone.

• Everything comes with a cost

Most crowdfunding platforms take a small fee or percentage of the fund you raise before letting you withdraw the money to your business/personal bank account. Some even have monthly fees.

If you go with rewards-based crowdfunding, you will have to give the incentives you promised whereas equity crowdfunding causes you to loose a percentage of ownership of your company or startup.

Whatever form it may take, a cost is still a cost so make sure you take everything into consideration before going through with anything.

What are the different types of crowdfunding?

• Donation-based crowdfunding

Any campaign in which there is no financial benefit for investors and contributors can be considered as donation-based crowdfunding. These campaigns are typically for disaster reliefs, charities, and non profits.

GoFundMe is the best donation-based crowdfunding platform ever created with over 2 million unique daily visitors. In addition, GoFundMe allows users to withdraw funds regardless of whether your campaign has met its goal or not.

• Rewards-based crowdfunding

A very similar approach to donation-based crowdfunding as it relies on small donations from a large number of individuals. The only difference is that backers will get incentives depending on the amount of their donation.

Small donations may result in a formal thank you whereas large donations may result in getting free limited-edition products or special discount codes. Whatever reward there may be, there will be no financial or equity return for your backers.

Kickstarter and Indiegogo are great platforms which use this approach.

• Peer-to-peer crowdfunding

You may have, at some point in your life, lent money to a friend. Why? Because you trust him and know that he would pay you back. Peer-to-peer crowdfunding is the online version of that.

Platforms such as LendingClub allows borrowers to loan money from individuals who are willing to take the risk.

Start loaning small amounts and make sure you pay back on time in order to build a reputable portfolio. Then you can start asking for larger sums of money.

Of course LendingClub is not the only option out there. You could also use Prosper.

• Equity crowdfunding

This allows backers to become co-owners of your business by trading capital for equity shares. This means they will receive a share of your profits as dividend.

Another difference in equity crowdfunding is that only accredited investors can invest in your campaign, not everyone.

AngelList, CircleUp, and FundersClub are some of the platforms that allow equity crowdfunding.

Tips to make your campaign successful

• Leverage social media

Share the link to your campaign on your social media. Even small donations from family and friends will help.

• Video works best

Videos are definitely more exciting and engaging than text. So convert the text into a short and compelling video and feature it on top of your campaign page.

In addition to that, videos bring better engagement and conversions than text on social media.

• Take all expenses in to account

People often forget about the expenses they had to incur to create the video, infographics as well as the platform fees. So take everything into consideration before finalizing how much capital you need to raise.

• Focus on the benefits of investors

Your investors will want to know what’s in it for them so give them something worth their investment. If you plan on giving limited-edition products, make sure they are of high quality and value.

Conclusion

Crowdfunding is a great way to raise capital for your project, startup or small business. There is no eligibility requirement. Anyone is free to create a campaign and start receiving funds.

Even though there are millions of potential investors and donors out there, not everyone would invest in your campaign so make sure it gets in front of as many eyes as possible.

Use digital marketing tactics like sharing and promoting your campaign on social media, running email campaigns, and reaching out to influencers using LikedIn and Twitter.

Be sure to create a detailed and compelling campaign profile with videos and infographics to get more attention.