‘Crowdfunding’ seems to be a hot topic for anyone who needs a cash injection into their business. But how does it actually work?
Quick takeaways if you’re in a hurry
- Crowdfunding websites allow many people to donate small amounts to help businesses, charities or individuals to reach their fund-raising goals
- There are two main types of crowdfunding – social crowdfunding and equity crowdfunding
- It’s important to choose your preferred website carefully. It needs to match your pitch, your audience, and reflect your funding goals.
Read on: A close look at crowdfunding websites
[estimated reading time: 6 minutes]
Crowdfunding websites are providing many enterprises with the ability to reach their audience. That audience has money to invest or donate, and is looking for the next opportunity. Depending on the type of crowdfunding site, businesses can pitch for different types of investment. While many aspects of finance and banking can appear to be complicated, crowdfunding is really quite a straightforward concept.
What is crowdfunding?
In the past, businesses seeking a cash injection for their business – either to fund start up, growth or a big project – had limited funding options. This usually involved choosing between finding a big investor willing to contribute to the company’s coffers, or approaching a bank or finance company.
Crowdfunding websites allow small to large groups of individuals to contribute small to medium quantities of cash in order to allow a person or organisation to reach their financial goals. Crowdfunding has been around for centuries in one form or another, but has gained traction since the launch of the first crowdfunding website in 2003. Today it is a multi-billion dollar global industry.
How does crowdfunding work?
The two most popular types of crowdfunding website are social crowdfunding and equity crowdfunding. A third type, known as debt crowdfunding or peer-to-peer lending is now growing in popularity as well.
Social crowdfunding
Social crowdfunding is a straightforward donation based funding model. The basic principle is that individuals or groups who want to raise money can put a pitch out through a social crowdfunding website and if people are interested they will donate to the cause. They either receive nothing in return or a small gift or reward. For example a new company may give them one of their products in exchange for a donation of a certain value.
Equity crowdfunding
If you’re willing to share ownership of your business as an incentive to build funds, then equity crowdfunding could work for you. Unlike social crowdfunding, equity crowdfunding actually gives those who are interested in your company the ability to donate and receive shares, or an equity stake. This requires a licensed equity crowdfunding provider and is subject to careful regulation.
Peer-to-peer lending
Unlike crowdfunding, peer-to-peer lending or debt crowdfunding is a funding situation where those providing the cash expect it back. It’s conducted online, through a third party website, and allows groups of lenders to combine to provide loans to those in need of cash. It’s a combination of lending and investment and so is often seen as more of an alternative financial service rather than a crowdfunding scenario.
So what’s the process?
If crowdfunding seems like something that could be of benefit to you, it’s worth spending some time researching the different websites available so that you can understand the pros and cons of each.
Different crowdfunding providers attract different types of pitches, so it’s important that you choose the best website for both your product and your target audience.
Once you’ve chosen your preferred site, you’ll need to prepare a pitch. The provider will then decide if it’s suitable to their audience, and if you’re given the green light you will be able to make the pitch on their website.
It’s your responsibility to spread the word about your campaign. Crowdfunding has been described as the social media of the funding world, and you’re going to need to put your network into play. Reaching your campaign targets will rely on a large audience where those who donate make small contributions. That means it’s crucial to spread your message far and wide.
When your campaign closes, your funds are not guaranteed. Some crowdfunding websites only release funds to you if you reach your campaign targets. It’s important to choose carefully upfront and decide whether to go with a site that will give you all the money donated or only give you donations if you hit your targets.
Whatever your end outcome in terms of money, remember there will be fees to pay for the service. These usually include a fee for taking part, and a percentage of any money raised. Due to the nature of the process, equity crowdfunding usually requires an upfront fee. It’s also important to be sure of your tax position on any funding received.
Crowdfunding is an excellent way to raise cash for your business or to fund an initiative. Choose your crowdfunding provider carefully and get advice if you can on the best site for your type of pitch. There is a great deal of importance in creating a pitch that will resonate with a wide audience: this is an investment in time and money, but done well should help you to gather the cash you need to take the next step. Businesses who use crowdfunding to gain funding for new ideas or start ups can also benefit from the valuable feedback that their pitch gets from both potential customers and investors.
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