What Is Equity Crowdfunding and How Does It Work?

  • Crowdfunding is when a “crowd” rather than one or two major investors funds a project or enterprise.
  • Crowdfunding can be divided into four categories: rewards, donations, debt, and equity.
  • To operate a successful crowdfunding campaign, you must attract a big number of backers and persuade them that your project is worthwhile of their money.
  • This guide is for entrepreneurs and small business owners who want to learn how to raise money through crowdfunding.

Crowdfunding is when a corporation, an organization, or a person raises money for a project without using traditional methods, usually by using modest donations from a large number of people.

This type of business can get off the ground or start new projects by acquiring the essential cash flow boost. The majority of these campaigns take place on the internet, have specified deadlines for raising funds, and declare specific financial goals.

Key takeaway: You can use four different types of crowdfunding campaigns for your business. Contributors to donation-based funding pay money without expecting anything in return. Backers of equity funding receive stock in the company.

Donors are repaid with interest for debt-based funding. Contributors earn tokens, items, or services in exchange for their donations through reward-based fundraising.

Related: A Step-by-Step Guide to Launching a Business

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 donate money to a campaign, a company, or a person in exchange for nothing. Let’s imagine you want to buy new equipment for your firm and you start a crowdfunding campaign. Individuals that donate you money do so solely to assist the growth of your company.
  • Debt: Debt-based donations are a type of crowdfunding known as peer-to-peer (P2P) lending. The money pledged by backers is a loan that must be repaid with interest by a set deadline in debt-based donations.
  • Rewards: Donors are rewarded when they receive something in exchange for their contributions. The incentives differ depending on the magnitude of the donation, incentivizing larger contributions. Participants may receive a T-shirt, a product, or a service based on how much money they donate to a campaign – sometimes at a discounted rate.
  • Equity: While some crowdfunding campaigns do not allow backers to own a piece of the firm they’re supporting, equity-based crowdfunding allows small businesses and startups to give away a piece of their company in exchange for funds. These contributions are a sort of investment in which participants obtain shares in the company based on the amount of money they donate.

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

Since 2009, Kickstarter has been a rewards-based donation platform that has assisted businesses in raising funds. More than $5 billion has been raised for more than 182,000 projects thanks to it. The ease of use of Kickstarter is one of the reasons for its success.

You choose a monetary goal and a time frame for achieving it, then describe the tale of your campaign. Then you share your project with the community in the hopes of receiving funding.

GoFundMe

GoFundMe is a donation-based crowdfunding platform that, while it’s most known for supporting humanitarian causes, may also be used by companies.

This is a fantastic alternative for nonprofits and corporations with service-oriented projects. According to statistics, one out of every ten campaigns on the platform is fully financed.

LendingClub

Because it is a peer-to-peer lending platform, LendingClub is a debt-based crowdfunding site. It provides personal loans of up to $40,000 and small business loans of up to $500,000. Each loan has a three-or five-year duration.

To be eligible, your firm must have been in operation for at least a year, the applicant must own at least 20% of the company, and it must generate $50,000 in yearly sales.

Indiegogo

Indiegogo is a reward-based crowdfunding site that accepts two types of contributions: Fixed funding allows you to set a fundraising goal for a specific amount of money, and if you don’t meet it, all donations are returned to donors.

When you need flexible funding, you can ask for any amount of money, and you can retain it all whether you meet your goal or not.

Crowdfunding rules

The majority of crowdfunding platforms have their own set of restrictions. For example, Kickstarter does not allow equity crowdfunding and includes a list of prohibited goods that you cannot include in your project.

It’s a good idea to study these regulations thoroughly before deciding on a platform so that you don’t have to stop your campaign before it ever gets started.

If you break the regulations and launch your crowdfunding campaign anyhow, your chances of success are slim. You must thoroughly investigate the various crowdfunding sites in order to choose which platform is appropriate for your company.

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 people believe that crowdfunding is a simple or free way to make money, but it takes a lot of work to create a project that backers would consider value.

Success isn’t guaranteed, and as the popularity of crowdfunding grows, backers are becoming more discerning about the initiatives they support.

“Crowdfunding works for all kinds of businesses at all stages,” said Kendrick Nguyen, CEO, and co-founder of crowdfunding platform Republic. “However, the companies that have the most successful campaigns tend to have the largest and most engaged communities behind them – usually of customers, users, or other supporters of their mission.”

It can be difficult to get such widespread support. It takes a powerful marketing campaign, dependable founders, and a high-quality product to succeed.

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:

  1. Finding and implementing a cost-effective marketing strategy before, during and after the campaign
  2. Crafting the right messaging in the campaign description will drive interest in the product or service.
  3. 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)
  4. Creating and planning the rewards program to strategically maximize the ROI 
  5. Finding the most effective and cost-efficient fulfillment method for the reward

“It’s vital to keep in mind that these are just the beginning of the barriers to consider when launching a crowdfunding campaign,” Sim stated. “Along with the more common ones, each creative will face problems that are unique to his or her firm.”

Other issues exist when it comes to equity crowdfunding. Equity crowdfunding, according to Connor Young, founder, and CEO of Ample Foods necessitates a greater focus on educating potential investors who do not necessarily have investment experience.

“We’re all so used to buying things online,” Young explained, “that investing in a standard crowdfunding campaign is fairly simple.” ‘Oh, OK, I’m effectively prepurchasing a product that doesn’t exist yet, and I’ll get it in six to twelve months,’ you remark.

That’s quite straightforward. Equity crowdfunding, on the other hand, is more difficult for someone who isn’t used to investing in businesses—for example, someone who isn’t an angel investor.

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. 

  • Crowdfunding provides investors with a low-risk investment opportunity. Investors do not have to be concerned about the effects of the economy or stock market on their investment because it is not part of the financial market.
  • Investing in a crowdfunding campaign is simple. A direct online procedure allows investors to invest in a project or company.
  • Equity crowdfunding allows investors to support several campaigns, allowing them to diversify their portfolios and broaden their financial potential.

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 emphasized the necessity of maintaining open lines of communication with backers throughout the process, including after the campaign has ended.

He highlighted that delays occur in practically every product launch, so you must expect them and respond with honesty and transparency.

“A lot of it boils down to ‘do you communicate well with your backers, even when things go wrong?'” says the author. Young stated the case.

It’s a good idea to give the community an update near the end of the campaign, detailing where they may reach you next and whether you plan to change your attention to preorders through your own website.

Don’t be hesitant to keep your backers updated after the campaign has ended.  Fostering relationships with supporters is at the heart of a successful crowdfunding campaign.

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 tends 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.

Prepare for the campaign before starting it for the best crowdfunding outcomes. Spread the word to your family and friends that you’ll be starting a campaign.

Prior to the launch, be active on your personal and company social media profiles. Make it as easy as possible for potential backers to locate you.

It takes time to create the right marketing materials. Don’t try to make an informative video the day before the campaign begins; give yourself plenty of time to perfect it.

Investing a few extra weeks in developing a strategy and raising awareness about your campaign will help you meet your crowdfunding target.

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 fantastic concepts fail, while others with simple premises succeed beyond all expectations. Crowdfunding initiatives have a viral development pattern and, as a result, are highly unpredictable without effective promotion.

“RadioPublic was one of my favorite investment campaigns on [Republic] to date,” Nguyen remarked. “They’re similar to SoundCloud for podcasts, and they’re backed by The New York Times, WordPress’ parent company, and the Bose Corporation.

They were able to generate just about $150,000 with the help of some of their most ardent users and listeners. They have a similar trajectory to Gimlet Media, which completed a $200,000 equity crowdfunding campaign in 2014 and was recently acquired by Spotify.”

Peak Design, which set a target of generating $500,000 on Kickstarter for its Travel Tripod product, is another firm that had a successful campaign. The campaign lasted 56 days and raised $27,168 from 27,168 backers.

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:

  1. If the campaign falls short of its goal, monies are returned to backers. If you don’t meet your target, some crowdfunding services still allow you to collect all of the money you’ve raised, though at a cost.
  2. If your campaign is a success, you will be paid the total amount you raised, less any processing fees. Kickstarter, for example, charges a 5% fee to host the fundraising and a percentage-based fee to handle payments. These payments are only necessary for successful crowdfunding projects; those that do not meet their financing target will not be charged.
  3. Because you still owe money to your donors, equity crowdfunding campaigns differ in how they end. This responsibility is contingent on the outcome of the donations.

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. 

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