What is Crowdfunding and How Does it Work?

What is Crowdfunding!

Essentially, crowdfunding involves lots of people – the crowd – investing money in a project. You can sell tickets for a sports competition or raise funds for a larger taco truck to raise money for something as diverse as a sports competition.

Small businesses can raise capital through three of the four types of crowdfunding available. Those who are not able to (or don’t want to) access traditional funding sources can use them.

Funding a new business venture through crowdfunding involves raising small amounts of capital from a large number of individuals. Social media and fundraising websites allow investors and entrepreneurs to interact through easy access to vast networks of people, with the potential to boost entrepreneurship by opening up 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. fundraising provides a forum to anyone with an idea to pitch it in front of waiting investors.

Crowdfunding sites offer you a place to host your campaign, usually in exchange for a percentage of the money raised. Backers are given various “rewards” based on the level of funding they provide. These rewards can include an exclusive promotional item, advance access to the product being supported, or some form of public recognition—the more funding offered, the better the reward. (Some campaigns offer equity in place of rewards, but in this guide, we’ll focus on the latter model.)

Most crowdfunding websites require you to set a financial goal for your campaign, as well as a timeframe in which to reach that goal, usually between 30 and 90 days. If you meet or don’t meet a campaign goal, you still get to keep all the money raised for your  goal or not. Other websites use an all-or-nothing model that returns funds to backers if your campaign falls short.

If your campaign is successful, you’ll be in an excellent position to transition into a sustainable business by leveraging the audience built through your crowdfunding efforts.

Related Article: Crowdfunding vs Peer to Peer Lending, Which is Better?