The term “crowdfunding” and the platforms that empower its use are changing the digital landscape for new companies seeking that first funding round. But as crowdfunding enters the mainstream consciousness, many are left wondering how it works. What is crowdfunding, exactly, what are the rules and where is this burgeoning industry going?
While the term itself was reportedly coined in 2006 by Michael Sullivan, an entrepreneur seeking to fundraise for a video blogging community, crowdfunding in practice has existed for centuries. Defined by Oxford Dictionary as “the practice of funding a project or venture by raising many small amounts of money from a large number of people” crowdfunding has been around in one form or another for hundreds of years.
One of the earliest and most well-known examples was spearheaded by newspaper publisher Joseph Pulitzer who asked readers to donate money to pay for the pedestal for what became the Statue of Liberty. The appeal raised a $100,000 in six months from 125,000 Americans. Today, of course, the term crowdfunding has become synonymous with its most popular web-based platforms, including Kickstarter, Indiegogo, RocketHub, RockthePost, and more.
Who Crowdfunds, and Why?
Initially, creative, philanthropic, and social endeavors most actively utilized crowdfunding to achieve their fundraising goals. Although these types of projects remain the mainstay of crowdfunding, driving 30% of all crowdfunding in 2012, other kinds of projects have increased in number and raised significant sums including startups, established businesses, entrepreneurs, artists, political organizations, and scientific researchers. Centered mainly on North America and Europe, crowdfunding has become an ever-more popular concept for organizations seeking funds and investment, and the industry has experienced huge growth in recent years.
In 2012, more than 300 crowdfunding platforms across the world raised a total of $2.7 billion, representing an 81% increase over the amount raised in 2011. Indeed, when all the numbers are tallied for 2013 the industry is expected to have raised $5.1 billion, or 89% more than the amount raised in 2012. Recent regulatory changes in the US (more on that soon) are likely to boost the continued development of the industry.
It is no coincidence that crowdfunding rose to prominence in the midst of tough economic times in America and around the world. As startups and small businesses found it increasingly difficult to secure investment capital through bank loans, angel investors, and other traditional sources, crowdfunding emerged in order to provide entrepreneurs with another, more accessible option. Of course, controversy over the potential for scamming remains, especially due to the skeptical attitude towards finance held by most Americans following the financial crisis.
Many analysts remain wary of the potential for another Bernie Madoff to hoodwink average Americans into giving up their hard-won assets. Nevertheless, increased regulation and oversight as well as proponents from the business community seem to have quelled many of the critics, at least for the time being.
Types of Crowdfunding
In keeping up with the growing demand for crowdfunding solutions, platforms have developed three types of crowdfunding. The first and most popular type of crowdfunding is referred to as donation or reward-based crowdfunding where project owners solicit (tax-deductible) donations from individuals or, in return for certain levels of investment, reward individuals with a variety of prizes. In 2012, these types of crowdfunding platforms raised $1.4billion of the total $2.7 billion raised.
The second type of crowdfunding is lending-based, in which project owners agree to repay their investors by a certain date. This type of crowdfunding, the second most popular kind, helped projects raise $1.2 billion in 2012.
The third type of crowdfunding is called equity-based crowdfunding, which allows investors to fund startup companies and small businesses in return for equity. Although this type of crowdfunding represented the smallest share of the three, raising only $116 million in 2012, new rule changes by the Securities Exchange Commission (SEC) promise to make it easier for startups and small businesses to raise more money online from both accredited investors and ordinary Americans.
In 2012, the US Congress passed the Jumpstart Our Business Startups Act (JOBS Act) in order to encourage more investment in smaller companies. In carrying out the requirements specified by the JOBS Act, the SEC proposed three rule changes that directly affect equity-based crowdfunding. First, last July the SEC approved a rule that lifted the ban on advertising for investors outside of public offerings, thereby making it easier for businesses to market directly to investors.
Then, in October the SEC proposed a rule allowing startups and small businesses to sell ownership stakes in their companies by soliciting accredited investors over the Internet. Specifically, businesses can raise no more than $5,000 from someone with less than $100,000 in income or net worth in one year, and no more than 10% of an individual’s income or net worth for individuals with more than $100,000 in income or net worth in one year.
Finally, in December the SEC unanimously proposed increasing the amount of money companies can raise under a simplified public offering from $5 million to $50 million while providing investors with fewer disclosures than those required for public companies.
Now that we know a little bit more about crowdfunding in general, what are some of the best crowdfunding sites? Of the hundreds of different platforms available, here is a short list with some of the best sites for each type of crowdfunding.
Donation (or Rewards) Based Crowdfunding
- Kickstarter: With over $220 million raised for over 61,000 launched projects, it’s no wonder that Kickstarter is the most well-known of all the crowdfunding sites. Projects that wish to raise money on Kickstarter must first submit their company information to be judged and approved by the platform. Kickstarter accepts most types of creative projects, with categories ranging from art and design to food and photography. Kickstarter does not allow fundraising for causes or awareness campaigns, charities, scholarships, or personal fulfillment projects.
Kickstarter also maintains an all-or-nothing funding policy, in which project owners set a funding goal and timeframe (at most 60 days) in which to meet it. If the goal is unmet by the end of the timeframe, the project receives none of the funds. According to Kickstarter, 81% of projects that raised more than 20% of their goal end up being successfully funded, and only 10% of projects end their campaign without receiving any pledges. Kickstarter charges a 5% feel for successfully funded projects.
- Indiegogo: As the name suggests, Indiegogo allows for a bit more independence than Kickstarter. Unlike Kickstarter, Indiegogo will accept projects about anything, including fundraising for a personal vacation or that that jetski you’ve always wanted. Indiegogo also offers two types of funding: Flexible and Fixed. The Fixed funding option is similar to Kickstarter’s all-or-nothing policy, whereas the Flexible funding option allows project owners to receive the money they raised even if they don’t meet their goal for a flat 9% fee. If a project is successful, the fee is 4% of the total amount raised. According to Indiegogo, 80% of projects fail to raise more than 25% of the total requested.
- SoMoLend: This platform helps small businesses and startups raise money from individuals, banks, and cities. With loan amounts generally ranging from $100,000 – $1 million, SoMoLend strives to increase transparency between borrowers and lenders by facilitating open communication between the two. When it comes to repayment, you simply repay the amount of money based on your loan agreement while SoMoLend handles the distribution for you. SoMoLend charges a 4% fee for all funds raised as well as a 1.8% portfolio management fee for investors.
- Kiva: Kiva works with another type of institution that has generated quite a bit of buzz in recent years, microfinance. Unlike most other funding platforms, Kiva doesn’t take any portion of funds raised, relying instead on donations, grants, and sponsorships. As it partners with microfinance institutions, the loans are generally much smaller than one will find on other sites, with the largest amount reaching $49,500. Since 2005 Kiva has raised over $393 million in loans. Importantly, Kiva is made for businesses in developing countries and is not available to American or other first-world companies.
- RockthePost: RockthePost matches accredited investors with high-quality startups. RockthePost places few limits on the types of companies and entrepreneurs who can list on their site, providing that they have a clear value proposition, are led by qualified teams, have a sizeable market, an appealing pitch, traction, as well as attractive growth and exit strategies. Projects on RockthePost raise on average between $100,000 and $5 million.
- AngelList: For those startups and small businesses looking for an easier way to attract angel and institutional investors, AngelList is for you. Although initially only catering towards the established investment community, AngelList has since began to open itself up to more crowdfunding. The AngelList team and a rotating group of analysts from major venture capital firms review startups after they’ve made their account and feature their favorites to investors.
Specialized Crowdfunding Platforms
Along with the many platforms that cater to projects located in a wide range of industries, there are several crowdfunding websites that cater to specific niches. For example, Healthfundr is restricted to only health and medical startups, as is the platform Medstartr. For artists and musicians, there are platforms such as PledgeMusic and Sellaband. There are even platforms made specifically for up and coming mobile apps like Appbackr and Apps Funder.
Be sure to do some investigation into whether there is a platform designed specifically for the industry you’re in before you start setting up your accounts.
With so many crowdfunding platforms online, it’s easy to get lost in the chaos of individual requirements, unique features, and other aspects each platform offers or requires. But just keep in mind these three simple tips when you’re building your crowdfunding profile so you can be sure your crowdfunding efforts are as successful as possible.
1. Get People Interested: When building your crowdfunding profile you need to create as compelling a page as possible to persuade users to contribute to your cause. No matter if you’re fundraising for a profitable venture or a charitable cause, it is more important that you explain not what you’re doing but why you’re doing it.
People want to feel like they’re a part of something bigger than themselves, so show them how your project connects them to a greater purpose or makes them feel like they are a part of something truly special and revolutionary. Also, think of creative and interesting rewards and benefits to provide your backers with. For example, one project fundraising for “zombie research” will send backers who pledge at least $20 a “cool parasite factoid” each month. Finally, make sure you are explicit in explaining exactly how you plan to use the money you raise.
2. Use Your Network: Once you’ve established the project, your next move is to tell everyone in your personal network about it. This includes friends, family, colleagues, previous donors, and anyone else who you know on a personal level. Encourage them to spread the word to their personal networks. Generally, the most successful crowdfunded projects receive 25-40% of their revenue from first, second, or third degree connections, so make sure you leverage your own network before trying to persuade strangers to support you. Also, make a dedicated Facebook page and regularly post information about your project like how much money you’ve raised so far, new updates and announcements, host a poll, advertise new rewards for backers, and more.
So now that you’re an expert in crowdfunding, it’s time to put your fingers on the keys and start researching the best platform for your project and fundraising goals. Some sites don’t like it if you try to raise funds on more than one crowdfunding platform, so be sure to pay attention to each platform’s terms of service. Above all, make sure that you’ve weighed the costs of exposing your private company to the prying eyes of the public against the benefits that crowdfunding can bring. Especially if you are working with proprietary technology, cover your bases with the necessary intellectual property documents before committing to any fundraising platform.
Good luck, and good crowdfunding!