What Is Crowdfunding for Startups?

FT Contributor
A businessman visiting a crowdfunding site on his laptop.

Whether you’re opening a restaurant, capitalizing on the latest internet of things trend, or attempting to finally turn that dream of starting a microbrewery into a reality, there are countless people around the globe looking for ways to get their startups off the ground.

One of the primary dampers for many entrepreneurs, though, is getting their hands on enough financing to help launch their company. There are only so many angel investors out there and going to family members for sizeable loans is a sticky business.

Fortunately, the modern, internet-driven world has provided an alternative: crowdfunding.

Table of Contents

Crowdfunding Definition

While traditional venture capital typically comes in rather large invested sums — often in the tens or hundreds of thousands of dollars — crowdfunding avoids this “one investor providing one large investment” concept by asking for small amounts of money from a very large number of individuals.

This is largely possible thanks to the explosive growth of both the World Wide Web, in general, and social media, in particular. This virtual “coming together” online has allowed entrepreneurs to solicit funds from thousands of contributors who, individually, wouldn’t be able to make a significant difference.

For instance, where an investor might have $10,000 to invest in a startup, a crowdfunding approach would attempt to raise the same sum from a couple of hundred individuals each offering $50 or $100 investments.

Crowdfunding is a flexible funding option that can be organized into several different categories (more on that below). However, while effective, there are several factors that should be considered when utilizing crowdfunding for your startup costs:

  • Typically the platform you use to gather donations will take a portion of your proceeds.
  • Often crowdfunding involves providing a reward or even partial ownership of the company to your new crowd of “micro” investors.
  • You must have a good product, pitch, or cause in order to ensure that an adequate number of investors are able to both find and contribute to your crowdfunding campaign.

If you’re comfortable with these requirements, you may be able to use crowdfunding to help fund your own business.

Crowdfunding Examples

There are numerous examples of crowdsourced companies at this point. For instance, the creators of the wireless smart in-ear headphones “The Dash” were able to raise $3,390,551 from nearly 16,000 backers.

Erick Migicovsky managed to make that number look small when he developed the e-paper watch Pebble. Migicovsky came up with the idea while in college, and the fan-favorite startup quickly racked up $10,266,845 from a staggering 68,929 investors.

You don’t have to be inventing a new technological gadget to find this kind of success, either. Take, for instance, the absurd yet popular party game Exploding Kittens, which racked up $8,782,571 from a robust 219,382 backers.

While the idea being backed can vary, the key to success in each of these scenarios is the fact that the product resonated with those who were investing in it.

Crowdfunding Categories

There are several different ways that crowdfunding can be structured:

Donation-Based Crowdfunding

One of the most common forms of mass fundraising, donation-based crowdfunding consists of a company or individual requesting donations in order to fund their efforts. People often use this form of fundraising for individual causes, such as paying for medical expenses. However, it can also be used to raise funds to pay for education or fund a nonprofit company.

Equity Crowdfunding

More traditional in nature, equity crowdfunding allows an entrepreneur to raise funds by offering a stake in their company to a large base of smaller investors. The classic example is purchasing shares, through which the investor would actually own a portion of the company.

Human Capital Crowdfunding

While most crowdfunding efforts focus on a product, a reward, donations, or equity, human capital crowdfunding literally raises money based on the prowess of a person. If someone is a top athletic prospect, for instance, they can crowdsource their college expenses in exchange for a portion of their lifetime earnings.

Peer-to-Peer Lending

Peer-to-peer lending is a way to gain traditional funding without the need for a traditional financial institution. It consists of lenders who are willing to invest their money by providing loans that are smaller, yet similar to bank loans. By utilizing online platforms set up to enable these financial exchanges, peer-to-peer lenders can loan money to smaller startups at a high-risk/high-reward rate.

Real Estate Crowdfunding

Real estate crowdfunding utilizes the power of crowdfunding to provide capital for real estate investments. The concept is fairly new to the scene, and some of its manifestations include raising capital for the construction or purchase of property as well as funding home improvement projects.

How Crowdfunding Works

While it’s fairly simple in concept, one question worth asking is how crowdfunding helps those who participate.

On the one hand, the entrepreneur who launches a crowdfunding campaign has one clear benefit: funding for their venture. However, this often comes at the sacrifice of products and the percentage of their funds taken by the crowdfunding platform. In addition, they may surrender a portion of their ownership to their investors — although this is offset by the fact that they do not lose control of their enterprise to a single venture capitalist.

The investors are typically given small yet potent compensation for their contributions. For instance, they may receive part ownership in the company, a source of passive income, or a reward such as products or services offered to them based on their level of investment.

Crowdfunding Sites

If you’re considering going the crowdfunding route, here are a few of the top sites being used by startups around the globe:

  • Kickstarter: This popular crowdfunding website has a massive crowd of investors and is a great place for general fundraising.
  • Indiegogo: Neck and neck with Kickstarter, Indiegogo is another extremely popular fundraising site that provides a variety of flexible investment options to offer to potential investors.
  • Upstart: This site, built by former Google employees, aims to provide loans based on risk determined by a powerful calculating model.
  • GoFundMe: GoFundMe focuses on donation-based fundraising for both individuals and nonprofits.
  • Mosaic: Mosaic is an equity crowdfunding site that provides loans for a variety of real estate ventures.

While these are some of the more successful sites, there are many other options available for your crowdfunding needs, no matter what your startup venture may be.

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