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How crowdfunding works for businesses
For small businesses to grow, sometimes you need to borrow capital. Unfortunately, small businesses often don’t fit the mold in terms of what a bank or larger institution requires to offer a loan.
But that doesn’t mean you’re out of luck. In recent years, the rise of crowdfunding has provided entrepreneurs with an alternative to traditional loans. In this article, we break down what crowdfunding is, how you can reward your backers and tips to running a successful campaign.
What is crowdfunding — and how does it work?
Crowdfunding is the process of raising money for a project or product online in small increments. Friends, family and strangers can contribute smaller sums to help you reach your total goal. What donors receive in exchange can vary based on the type of crowdfunding you use.
Compare top 15 crowdfunding sites
Four types of crowdfunding
- Donation-based crowdfunding
Donation-based crowdfunding allows individuals, entrepreneurs and small businesses to set a goal for funding. Individuals can donate money simply to help reach that goal — without gaining anything in return.
GoFundMe is a top donation-based crowdfunding platform, with an average 2.3 million monthly users. The site allows users to collect funds regardless of whether they’ve met their stated goal. Unlike other platforms, GoFundMe doesn’t offer rewards to backers.
- Rewards crowdfunding
Rewards crowdfunding is similar to donation-based crowdfunding in how it relies on small donations from a large number of backers. The difference is that backers are offered different incentives that vary by the amount their donation: A small contribution may result in no reward or a nominal thank you, while larger contributions could allow backers discounts or perks for the specific goal they’re backing. This method of crowdfunding is great for startups that want to test their idea on the market — if your budding business can’t attract funds with the promise of a copy of your product, then it probably won’t be enticing to customers.
Of the rewards-based crowdfunding platforms, Kickstarter and Indiegogo are among the best known.
- Kickstarter works with a goal-based model: You set a goal at the start of your campaign that you must reach in order to receive your funding. This places more importance on setting reasonable goals.
- Indiegogo doesn’t come with the same all-or-nothing approach. Instead, you can choose to pay a fee of up to 9% in order to receive funding whether you hit your goal or not. The upside is that you get your funding no matter what — but without a goal, you could be missing out on a motivator both for you and for the backers. (Or your ability to leverage FOMO.)
If you’re in a specialized industry, you could find smaller platforms focused on specialities like nonprofits or health care.
- Equity crowdfunding
Some crowdfunding platforms allow small businesses to get funding in exchange for equity. With this model, backers can become shareholders, gaining a percentage of the potential future return.
Crowdfunder and CircleUp are two widely used platforms for equity investing. To use Crowdfunder, you pay a flat monthly fee of $450 to $750, while CircleUp takes a percentage of the funds you raise.
You’ll also find specialty platforms for equity crowdfunding. An example of this is Fundanna, an equity crowdfunding platform for cannabis businesses. Because cannabis is classified as a Schedule I drug, banks and other lenders are prohibited from financing cannabis companies. Fundanna helps connect cannabis business owners with investors who give money in exchange for equity.
- Peer-to-peer crowdfunding
Unlike other crowdfunding models, peer-to-peer (P2P) fundraising can widen the audience you reach with your fundraising efforts. With P2P, individual backers reach out to their own social networks to raise funds. On the platform Classy for example, instead of offering incentive levels with equity, nonprofits encourage team members to organize campaigns and then can offer incentives like T-shirts or other tangible rewards outside of the platform.
For a less public way to request funding help, you could apply for a small business loan through a peer-to-peer lender like LendingClub or Bitbond. These lenders use a similar model in allowing individuals to fund whole or partial loans to small business owners.
Crowdfunding benefits and drawbacks
- You can use your social network. Leverage your friends, family and acquaintances to support your project. This is great for startups just beginning to raise money for their business.
- Access to crowdfunding communities. Popular platforms have their own following, giving you access to a wider audience.
- Get valuable project feedback. How individuals respond to your funding campaign can provide feedback on whether there’s interest in your venture — before you bring it to the market.
- Incentives for customers. Providing rewards, special perks, and even equity can be a great way to entice potential customers to provide funding for your business.
- You can get funds quickly. Crowdfunding platforms typically give supporters a 30-90 day window to provide financial backing for your business. The slim timeframe can lead you to get funding much quicker.
- You can exhaust your social network. If you’re relying on your social circle for funding, choose projects carefully to avoid bombarding your friends and family.
- You’ll need to invest time in your campaign. If you want people to back your project, you’ll typically need a sharp-looking video and enticing campaign page.
- It comes at a cost. You’ll likely pay some fee or percentage to get funded. With rewards crowdfunding, you have to deliver the incentives you promise, while you’ll give up a percentage of your potential earnings with equity crowdfunding.
Five tips for a successful crowdfunding campaign
- Reach out to your social network. This is the time to call in favors. Even smaller donations will add up to a successful crowdfunding campaign — this is especially true for startups.
- Put together a solid marketing plan. You can’t just put your campaign up and hope for the best — especially on Kickstarter and Indiegogo. Plan transparent marketing through social media, video and email to spread the word about your campaign.
- Produce a crowdfunding video. Detailing your project through a compelling video can personalize your goals and get people excited. Facebook continues to prioritize video in its newsfeed, potentially influencing the visibility of what you’re working on.
- Know how much you actually need. Each crowdfunding platform comes with its own fees. Learn what you’ll pay, and adjust your goal so that you don’t end up short.
- Focus on the benefits for your backers. You’re crowdfunding to finance your business — but your backers will want to know what’s in it for them.
Frequently asked questions about crowdfunding
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