Crowdfunding: What It Is, How It Works, Popular Websites
What Is Crowdfunding?
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists.
How Crowdfunding Works
In most jurisdictions, restrictions apply to who can fund a new business and how much they are allowed to contribute. Similar to the restrictions on hedge fund investing, these regulations are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. Because so many new businesses fail, their investors face a high risk of losing their principal.
Crowdfunding has created the opportunity for entrepreneurs to raise hundreds of thousands or millions of dollars from anyone with money to invest. Crowdfunding provides a forum to anyone with an idea to pitch it in front of waiting investors.
One of the more amusing projects to receive funding was from an individual who wanted to create a new potato salad recipe. His fundraising goal was $10, but he raised more than $55,000 from 6,911 backers.1 Investors can select from hundreds of projects and invest as little as $10. Crowdfunding sites generate revenue from a percentage of the funds raised.
Types of Crowdfunding
The two most traditional uses of the term reflect the type of crowdfunding done by start-up companies looking to bring a product or service into the world and by individuals who experienced some type of emergency. Many individuals affected by a natural disaster, hefty medical expense, or another tragic event such as a house fire have received an amount of financial relief they wouldn't otherwise have had access to thanks to crowdfunding platforms.
However, in recent years, some crowdfunding platforms such as Patreon and Substack have extended the reach of crowdfunding to offer a way for creative people—artists, writers, musicians, or podcasters—to sustain their creative work by receiving a steady source of income.
Popular Crowdfunding Websites
Crowdfunding websites such as Kickstarter, Indiegogo, and GoFundMe attract hundreds of thousands of people hoping to create, or support, the next big thing.
GoFundMe
As of 2021, GoFundMe is the largest crowdfunding platform. Since GoFundMe was founded in 2010, the site has raised over $15 billion through more than 100 million donors.2 GoFundMe is the site most popular for individuals seeking to recover from a medical expense or disaster such as a house fire, natural disaster, or unexpected emergency expense. Start-up companies tend to use Kickstarter.
Kickstarter
Kickstarter is another popular choice. As of May 29, 2022, since it was founded in 2009, Kickstarter has successfully funded over 220,000 projects, with more than $6.6 billion pledged across all Kickstarter projects.3
Kickstarter is the most popular crowdfunding site for aspiring businesses hoping to raise capital and reach a larger audience. In fact, unlike GoFundMe, Kickstarter can only be used for creating projects that can be shared with others.
Additionally, Kickstarter cannot be used to raise funds to donate to a charity or cause, projects can't offer incentives like equity, revenue sharing, or investment opportunities, nor can any project involve the site's list of prohibited items such as "any item claiming to diagnose, cure, treat, or prevent an illness or condition," political fundraising, drugs or alcohol, or any contests, coupons, gambling, and raffles.4
Indiegogo
Indiegogo started as a crowdfunding site initially focused exclusively on raising money for independent films but began accepting projects from any category a year after its launch in 2008.5
Indiegogo is seen as a less strict and more flexible platform than Kickstarter, as it gives backers control over whether they want fixed or flexible models—this is probably the most significant difference between the two crowdfunding platforms. Kickstarter releases funds only after the campaign has reached its funding goal, whereas Indiegogo allows the campaigner to receive funding pro-rata, or wait until their target is hit.
As a campaigner, it might be easier and less risky to go with flexible funding (i.e., receiving funds as they come); however, regardless of the amount raised, campaigners must still deliver on any promises made. For a backer, fixed funding is more attractive as it is associated with much less of a risk.
Crowdfunding platform fees range from 5% to 12%. Look out for punitive fee structures before choosing a crowdfunding platform.
Advantages and Disadvantages of Crowdfunding
The most obvious advantage of crowdfunding for a start-up company or individual is its ability to provide access to a larger and more diverse group of investors/supporters. With the ubiquity of social media, crowdfunding platforms are an incredible way for businesses and individuals to both grow their audience and receive the funding they need.
Furthermore, many crowdfunding projects are rewards-based; investors may get to participate in the launch of a new product or receive a gift for their investment. For instance, the maker of a new soap made out of bacon fat may send a free bar to each of its investors. Video games are a popular crowdfunding investment for gamers, who often receive advance copies of the game as a reward.
Equity-based crowdfunding is growing in popularity because it allows startup companies to raise money without giving up control to venture capital investors. In some cases, it also offers investors the opportunity to earn an equity position in the venture. In the United States, the Securities and Exchange Commission (SEC) regulates equity-based crowdfunding.
Potential disadvantages of crowdfunding include the possible damage to you or your company's reputation caused by "resorting" to crowdfunding, the fees associated with the crowdfunding site, and, at least on some platforms, if you don't reach your funding goal, any finance that has been pledged will be returned to your investors and you will receive nothing.
Great way to interact with potential consumers
Ability to gauge public opinion on your product
In some cases, if you don't reach your funding goal, any finance that has been pledged will be returned to your investors
Possible damage to your start-up company's reputation
Examples of Crowdfunding
Many of the products and businesses crowdfunded on Kickstarter became very successful and lucrative endeavors. For instance, Oculus VR, an American company specializing in virtual reality hardware and software products, was funded through the site. In 2012, founder Palmer Luckey launched a Kickstarter campaign to raise money to make virtual reality headsets designed for video gaming available to developers. The campaign crowdfunded $2.4 million, ten times the original goal of $250,000.6 In March 2014, Facebook, now Meta (META), acquired Oculus VR for $2.3 billion in cash and stock.
Another example of a company that rose to success through the help of Kickstarter campaigns is M3D, a company founded by two friends that manufacture small 3D printers. David Jones and Michael Armani raised $3.4 million for their Micro 3D printer on the crowdfunding site in 2014.7 The tiny 3D printer, which comes with a variety of durable 3D inks, is now available at Staples, Amazon.com, Inc. (AMZN), Brookstone, and elsewhere.
In April 2019, Critical Role, a weekly live-streamed tabletop roleplaying game featuring a group of prominent voice actors, raised $4.7 million in just 24 hours for its latest animated special “The Legend of Vox Machina.” No other 2019 Kickstarter campaign raised that amount over their entire 30- to 60-day raising period.8
What Is crowdfunding and how does it work?
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Depending on the type of crowdfunding, investors either donate money altruistically or get rewards such as equity in the company that raised the money.
Do you pay back crowdfunding?
For crowdfunding that operates on a donation basis, the company does not need to pay back investors. However many companies offer incentives for early backers such as an advance copy of the product.
Is crowdfunding legal in Australia?
Yes. In 2017, the Australian government amended the 2001 Corporations Act to provide a legislative framework for crowd-sourced funding.9
Is crowdfunding legal in Nigeria?
All Micro Small and Medium Enterprises (MSMEs) incorporated as a company in Nigeria with a minimum of two-years operating track record are eligible to raise funds through a Crowdfunding Portal, in exchange for the issuance of shares, debentures, or such other investment instrument as the Commission may determine from time to time.
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How crowdfunding works
Crowdfunding can get you money to build a business, and the attention to build a customer base.
What is crowdfunding?
At a basic level, crowdfunding is lots of people – the crowd – putting in money to support a project. It could be for something as diverse as a trip to a sports competition or to raise money for a bigger taco truck.
There are four different types of crowdfunding and three of them are relevant to small businesses raising finance. They can be especially useful for those who can’t (or don’t want to) get funds through traditional sources.
- Kickstarter (rewards)
- Indiegogo and Crowdfunder (rewards/donations)
- GoFundMe and JustGiving (donations)
What Is Crowdfunding?
Need funds for your business? Here's what you should know about crowdfunding.
- Crowdfunding is when a “crowd” funds a project or business, rather than one or two major investors.
- There are four different types of crowdfunding: rewards, donation, debt and equity.
- To run a successful crowdfunding campaign, you need to capture the attention of a large number of backers and convince them that your project is worthy of their investment.
- This guide is for startups and small business owners who are interested in learning how crowdfunding can be used to obtain funding.
Crowdfunding is when businesses, organizations or individuals fund a business without traditional means with small donations from many people. By receiving the necessary boost to cash flow, these ventures can get off the ground or launch new projects. Most of these campaigns happen via internet platforms, have set time frames for when money can be raised and disclose specific monetary goals.
Key takeaway: There are four kinds of crowdfunding campaigns you can use for your business. With donation-based funding, contributors give money without receiving anything in return. In equity funding, backers get shares of the business. For debt-based funding, donors are repaid with interest. With reward-based funding, contributors receive tokens, products or services in return for their donations.
Types of crowdfunding
While there are four types of crowdfunding, each receives money from interested donors. Here’s a breakdown of each one:
- Donation: Donation-based crowdfunding is when people give a campaign, company or person money for nothing in return. Let’s say you create a crowdfunding campaign to purchase new equipment for your company. The individuals who give you money do it out of support for the growth of your business and nothing else.
- Debt: Debt-based donations are peer-to-peer (P2P) lending, which is a form of crowdfunding. In debt-based donations, the money pledged by backers is a loan and must be repaid with interest by a certain deadline.
- Rewards: This is when donors receive something in return for their donations. The rewards vary by the size of the donation, which incentivizes higher contributions. Based on how much money participants give to a campaign, they may receive a T-shirt, the product or service – often at a discounted rate.
- Equity: While some crowdfunding campaigns don’t allow backers to own a portion of the company they’re supporting, equity-based crowdfunding allows small businesses and startups to give away a portion of their business in exchange for funding. These donations are a type of investment, where participants receive shares in the business based on how much money they contribute.
Examples of successful crowdfunding sites
There are many online crowdfunding platforms you can use to kick off your business. Here are four of the top crowdfunding sites you can use to grow your company.
Kickstarter
Kickstarter is a rewards-based donation platform that has been helping companies raise money since 2009. It has been used to raise more than $5 billion for more than 182,000 projects. Part of what makes Kickstarter so successful is how simple the site is to use. You set a monetary goal and the amount of time you want to reach it, and tell your campaign’s story. You then share your project with the community in hopes of finding backers.
GoFundMe
GoFundMe is a donation-based crowdfunding company, and although it’s famously used for more charitable initiatives, businesses can take advantage of the platform as well. This is a great option for nonprofit organizations and businesses that have service-based initiatives. Statistically, 1 in 10 campaigns is fully funded on the site.
LendingClub
LendingClub is a debt-based crowdfunding site because it is a P2P lending platform. It offers up to $40,000 in personal loans and up to $500,000 in small business financing. Each loan term is three or five years. To qualify, your company needs to have been in operation for at least a year, the applicant must own at least 20% of the business, and it must have an annual sales revenue of $50,000.
Indiegogo
Indiegogo is a reward-based platform that offers two kinds of funding. Fixed funding allows you to set a goal for a certain amount of money, and if you don’t reach your target, all funds are returned to donors. Flexible funding is when you’re looking for any amount of monetary support, all of which you can keep whether you hit your goal or not.
Crowdfunding rules
Most crowdfunding sites have specific rules. Kickstarter, for example, doesn’t allow equity crowdfunding and has a list of prohibited items that you are not allowed to include in your project. It’s wise to read these rules thoroughly before choosing a platform so you don’t have to halt your campaign before it even starts.
If you ignore the rules and jump into your crowdfunding campaign, the likelihood of success plummets. You need to adequately research the different crowdfunding sites so you understand which platform works best for your business.
Key takeaway: Before choosing a crowdfunding site, review each platform’s rules to ensure you choose the right one for your campaign. Also consider reading our guide to finding a loan provider
The challenges of crowdfunding
Many individuals assume crowdfunding is an easy or free way of making money, but it requires a lot of effort to establish a project that backers will perceive as a valuable service. Success isn’t guaranteed, and as crowdfunding continues to gain popularity, backers have become shrewder in the projects they support.
“Crowdfunding works for all kinds of companies at all different stages, but the companies that have the most successful campaigns tend to have the largest and most engaged communities behind them – usually of customers or users or other supporters of their mission,” said Kendrick Nguyen, CEO and co-founder of crowdfunding platform Republic.
Generating this type of widespread support can be a challenge. It takes a strong marketing effort, trustworthy founders and a quality product. According to Ryan Sim, managing director and co-founder of We The People – a company that sells only crowdfunded products – the challenges of crowdfunding are extensive. He listed five key challenges that plague reward-based crowdfunding campaigns:
- Finding and implementing a cost-effective marketing strategy before, during and after the campaign
- Crafting the right messaging in the campaign description that will drive interest in the product or service
- Developing an informative and exciting campaign video that explains the product and its benefits (the main challenge being that it’s expensive to create a really good and high-impact video)
- Creating and planning the rewards program to strategically maximize the ROI
- Finding the most effective and cost-efficient fulfillment method for the rewards
“It’s important to note that these challenges are just the start of the obstacles to consider when creating a crowdfunding campaign, “said Sim. “In addition to typical ones, every creator will have his own challenges that are very unique to his or her business.”
Other challenges also arise in equity crowdfunding. According to Connor Young, founder and CEO of Ample Foods, equity crowdfunding requires more emphasis on educating potential investors who don’t necessarily have an investment background.
“We’re all so used to buying products online, so investing in a regular crowdfunding campaign is quite easy,” said Young. “You just say, ‘Oh, OK, I’m basically prepurchasing a product that doesn’t exist yet, and I’m going to get it in six to 12 months.’ That’s pretty easy to understand. But for a person who’s not actually used to investing into companies – they’re not a typical angel investor – equity crowdfunding naturally has more resistance.”
Key takeaway: It takes a lot of work to run a successful crowdfunding campaign; launching one doesn’t guarantee success. It’s important to make sure your marketing message is well thought out and to find cost-effective methods to promote your campaign and reward backers.
Crowdfunding benefits for investors
Investors have a lot to gain from putting their money into crowdfunding campaigns.
- Investors appreciate a low-risk venture, and crowdfunding offers just that. Since it’s not part of the financial market, investors don’t have to worry about the effects of the economy or stock market impacting their investment.
- It’s easy to invest in a crowdfunding campaign. Investors can put money into a project or company through a direct online process.
- Equity crowdfunding allows investors to fund multiple campaigns, which helps them to expand their financial opportunities and diversify their portfolios.
Key takeaway: Investing in projects through crowdfunding sites is easy, with flexible and direct payment options. Investors can use crowdfunding to diversify their portfolios.
Tips for crowdfunding success
There’s no one-size-fits-all approach to crowdfunding, but there are three key places to start on your road to crowdfunding success.
1. Communicate with backers.
Young stressed the importance of being transparent with backers throughout the process, even after the campaign ends. He explained that nearly every product launch experiences delays, so you have to expect things to go wrong and react with honesty and transparency.
“A lot of it is simply ‘do you have good communication with your backers, even when things go wrong?'” Young said.
Toward the close of the campaign, it’s often good to update the community, explaining where to reach you next and whether you plan on shifting focus to preorders through your own website.
Don’t be shy about keeping your backers in the loop once the campaign ends. A successful crowdfunding campaign centers on fostering relationships with supporters.
2. Share relevant and engaging marketing materials.
A good batch of marketing materials will help your campaign stand out.
“It’s about making an emotional connection with someone just as much as it is about actually explaining what the product is,” Young said. “One of the really big reasons why someone invested in the first place to Ample was simply because they thought that I was an authentic guy and that I really seemed to care and be passionate about it.”
With new crowdfunding campaigns launching daily, it’s important to make your campaign stand out from the others. Creating strong marketing materials and spreading the campaign through your network tend to be the best ways of gaining recognition. Ample used a brief video to explain its product during its first crowdfunding campaign.
3. Prepare for the campaign.
For the best crowdfunding results, prepare for the campaign before launching it. Spread the word to your family and friends that you’re going to launch the campaign. Be active on your personal and company social media accounts prior to the launch. Give potential backers every chance to find you.
Creating the proper marketing materials also takes time. Don’t try to film an educational video the day before the campaign starts; give yourself time to get it right. Taking a few extra weeks to develop a plan and build excitement around the campaign can help you hit your crowdfunding goal.
Key takeaway: To reach your funding goal, you must do more than launch a crowdfunding campaign for your project. Market to your base before and during your campaign, and provide updates on your business’s progress to develop a relationship with your backers.
Examples of successful crowdfunding campaigns
Not all projects succeed. Few of them even obtain significant levels of funding.
Many projects with excellent ideas end up failing, whereas others with simple premises flourish beyond all expectations. Crowdfunding projects tend to follow a viral method of growth and, as such, are quite unpredictable without the proper marketing.
“One of my favorite investment campaigns on [Republic] to date was RadioPublic,” Nguyen said. “They’re kind of like SoundCloud for podcasts and have investors like The New York Times, the parent company of WordPress and the Bose Corporation. They raised just under $150,000 from some of their most passionate users and listeners. To me, their trajectory is similar to Gimlet Media’s – they ran a $200,000 equity crowdfunding campaign in 2014 and were just acquired by Spotify this month.”
Another company that ran a successful campaign is Peak Design, which set a goal to raise $500,000 on Kickstarter for its Travel Tripod product. The campaign lasted 56 days and had 27,168 backers, raising $12.1 million.
Key takeaway: The success of your crowdfunding campaign depends on your ability to capture the interest of many people and build a relationship with your base.
Concluding a campaign
Once your crowdfunding campaign closes, one of three things happens:
- If the campaign didn’t reach its target amount, funds are returned to the backers. Some crowdfunding websites still allow you to collect all the money you raised if you fail to reach your goal, though often at an additional expense.
- If the campaign was successful, you receive the total amount of money you raised, minus processing fees. For example, Kickstarter charges a 5% fee for hosting the fundraiser and a percentage-based fee for payment processing. These payments are only required for successful crowdfunding projects and will not be charged to any that don’t reach their goal amount.
- Equity crowdfunding campaigns differ in how they conclude, as you still have an obligation to the backers. That obligation depends on how the donations play out.
While crowdfunding does not guarantee the success of a project or the longevity of a company, it helps many entrepreneurs gain business experience and create relationships for other opportunities.
Crowdfunding FAQs
What is crowdfunding?
Crowdfunding involves collecting money from a group of donors in an effort to raise capital. Crowdfunding sources can include those who have an interest in your business: friends, family members, investment groups and personal investors. The goal is to attract a large group to your investment to raise the capital you need for your business venture. Crowdfunding typically occurs online through dedicated platforms.
Do you pay back crowdfunding?
Donation crowdfunding does not require the recipient to pay back the funds. This type is typically more geared to charities and nonprofits. Friends and family members are likely to not expect a return of their funds. Debt-based donations comprise money pledged by backers that is a loan, which you must repay with interest. With rewards-based crowdfunding, tangible items, like free products, are given to individuals who give money to help you start your business. You could structure your rewards based on the size of the donation. For equity crowdfunding, participants receive a financial reward for their investment by owning shares of your company.
What are the pros and cons of crowdfunding?
There are both pros and cons of raising capital through crowdfunding. The following are the advantages of using the strategy:
- Little financial risk
- Increased brand awareness
- Free marketing
- Option to test the market prior to launch
- Control over equity
The following are drawbacks to consider before launching a crowdfunding venture:
- Crowdfunding requires large amounts of time and effort
- Oversaturated market
- Potential for no to little gain
- Scams are more likely
Key takeaway: If you don’t hit your funding goal, the crowdfunding platform usually returns the money to donors, though some sites let you keep the funds for a fee. Be aware of any processing and hosting expenses as well.
Bennett Conlin and Ryan Goodrich contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.
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