For many founders and business owners, finding funding is always a priority. This is especially true for newer businesses and startups that may not have even launched their product yet. Fortunately, there is a business model that can help both types of businesses get funding.
Crowdfunding has revolutionized the way individuals and businesses raise capital for their projects. This type of business model involves gathering financial contributions from a large number of people, typically via the Internet. This modern fundraising method offers a variety of models, each with its unique characteristics and benefits. Understanding these business models is crucial for anyone looking to leverage crowdfunding for their endeavors.
While this may seem like a fantastic way to raise money, it is not guaranteed. In fact, on average, 22.4% of the projects that are crowdfunded are successful. There may be many reasons why this is. Sometimes creators and businesses choose the wrong type of crowdfunding model. Choosing the wrong model can be devastating for a business looking to use crowdfunding to raise funds, awareness, and potential customers.
In this article, we’ll look at the different types of crowdfunding out there and how they work. But first, let’s define the crowdfunding business model.
What is the Crowdfunding Business Model?
Crowdfunding can take various forms, but its essential concept involves raising funds for a venture by collecting money from many individuals. Pooling small amounts of money from multiple organizations and people to finance a project or cause, would be a crowdfunding campaign.
Individuals often use platforms or websites like GoFundMe or Change.org. Businesses usually use platforms like Kickstarter and Indiegogo. This is because the latter two platforms focus on helping startups raise money by attracting the type of donors and investors to the platform that will be more likely to contribute. These platforms allow creators to showcase their ideas and solicit funds from a broad audience.
A key advantage of the crowdfunding model is its ability to validate a concept or project in the market. Businesses can assess the feasibility and demand for their product or service before even fully launching. This makes sense because if donors, investors, and supporters are willing to give money to a project, they are more likely to purchase the product or service the startup or business offers in the future.
An example of successful crowdfunding is the Pebble Time smartwatch. In 2015, Pebble launched a Kickstarter campaign to fund their new smartwatch. The campaign reached its funding goal within minutes and went on to raise over $20 million, making it one of the most successful crowdfunding campaigns at the time. This demonstrated the potential of crowdfunding in not only securing necessary funds but also in validating product demand and building a strong base of early adopters and brand advocates.
Types of Crowdfunding Business Models
1. Donation-Based Crowdfunding
Donation-based crowdfunding is what most people think of when they think of crowdfunding. This is because it is not only used by businesses to raise money for a product launch but also by individuals who need funds for something. A parent, for example, may start a donation-based crowdfunding campaign to help pay for college expenses.
In donation-based crowdfunding, contributors offer financial support purely because they choose to. There is no real expectation of any tangible return. That is why it is effective for disaster relief, medical expenses, social justice campaigns, and various community projects.
However, businesses are also taking advantage of this model. Startups and social enterprises business tend to use this model to raise capital. In this model, individuals donate money to a business project or cause without expecting any financial return.
Instead, donors may receive non-monetary rewards or acknowledgments. However, it is not expected since getting a reward would be reward-based crowdfunding (we’ll discuss that in the next section). For example, startup founders may send a handwritten note, personalized “thank you” video, or card to a donor because they contributed to the campaign.
However, there are challenges and limitations to this model. One major concern is the reliance on the emotional appeal of a campaign. This may not work with many if they do not feel connected to what the business is trying to achieve or the cause the social enterprise is trying to support. Success using the donation-based crowdfunding model boils down to being able to tell a great story and exceptional marketing strategy.
There’s also the risk of donor fatigue. We’re continuously bombarded with requests for contributions from friends, non-profits, and others. This can lead to a decrease in the overall willingness to donate.
2. Reward-Based Crowdfunding
In the previous section, we mentioned that donation-based crowdfunding can include giving donors a reward but it is not necessarily expected. The type of crowdfunding business model where a reward is expected is called Reward-based crowdfunding. This model is one of the most successful types of crowdfunding.
In this model, individuals or entities offer rewards or incentives in exchange for financial contributions. These rewards are often tiered based on the contribution amount. These range from small tokens of appreciation like thank you notes or merchandise. But they can be more substantial. For example, a software startup can allow early access to a product or unique experiences for donation.
The appeal of reward-based crowdfunding lies in its mutual benefit for both project creators and backers. For creators and businesses, it provides a platform to finance their projects without the need for traditional loans or investments. It also allows them to simultaneously validate their ideas and gauge market interest.
This validation can be crucial for early-stage projects. They get a double dose of benefits because it helps the business secure funding and also helps build a community of supporters who are invested in the project’s success.
For backers, reward-based crowdfunding offers a chance to be part of a project they believe in and to receive unique rewards that are often exclusive or limited in nature. There, however, are some drawbacks and risks associated with this crowdfunding model. For one, project failure or delays.
Reward-based crowdfunding primarily relies on the creator’s commitment to delivering the promised rewards. If a project fails or is significantly delayed, backers may not be happy. Backers expect rewards so they may be patient if there are some delays but there is a risk of backlash if the project never goes through and is delayed too long.
3. Equity Crowdfunding
The total spend on our next type of crowdfunding model is forecasted to reach $2.4 billion by the end of this year. Needless to say, this is one of the go-to crowdfunding options for many startups.
In this model, individuals or entities invest money in a company in exchange for equity shares, essentially becoming shareholders and owning a part of the company. This method of crowdfunding has democratized the investment process. Instead of looking for venture capital or angel investment, businesses can allow everyday investors a chance to fund ventures they believe in. The primary advantage of equity crowdfunding for startups is its ability to connect startups with a broad pool of potential investors.
For investors, on the other hand, the equity crowdfunding model presents a chance to diversify their portfolio. This is because they can now invest in emerging companies. This type of crowdfunding is different from the previous 2 we mentioned.
Primarily, because there are financial benefits for both the organization running the campaign and the investors. This potential for high returns, however, comes with a higher risk, as startup investments can be speculative and illiquid.
One of the main concerns is the inherent risk in startup investing. Many startups fail, and investors may lose their entire investment. Unlike debt crowdfunding (we’ll touch on that next), where there is a structured repayment plan, equity crowdfunding relies entirely on the success of the business.
Another challenge is the regulatory landscape. Equity crowdfunding is subject to stringent securities laws and regulations, which can vary significantly from country to country. These regulations are in place to protect investors but can also pose barriers for companies seeking to raise funds.
4. Debt Crowdfunding
Debt crowdfunding is also commonly known as peer-to-peer lending or crowdlending. This form of crowdfunding connects individual lenders with borrowers through online platforms. This allows for the direct lending of funds. The borrowers then repay these loans over a specified period, typically with interest. This model is especially beneficial for individuals or businesses that might not have access to traditional banking loans, due to stringent credit requirements or other regulatory hurdles. This type of crowdfunding takes a page from the peer-to-peer business model in its structure.
One of the primary advantages of debt crowdfunding is its accessibility. It opens up ways for funding that were previously unavailable to certain segments. For example, small businesses and individuals with less-than-perfect credit histories. This inclusivity not only helps borrowers but also provides lenders with a wider range of investment opportunities.
From an investor’s perspective, debt crowdfunding can be attractive due to potentially higher returns compared to traditional savings or fixed deposit accounts. This model also allows for the diversification of investment portfolios, as lenders can spread their risk by funding multiple borrowers with varying levels of investment.
However, debt crowdfunding is not without its challenges and risks. The most significant concern is the risk of default by borrowers. Since most crowdlending platforms do not require collateral, lenders may have limited recourse if a borrower fails to repay the loan.
This risk is somewhat lowered by the platforms through credit checks and risk assessments. However, that doesn’t completely eliminate the risks. Another concern is the lack of liquidity, as funds invested in debt crowdfunding are tied up for the duration of the loan, which could range from a few months to several years.
While the crowdfunding business model is not right for all types of businesses, it should be considered as a viable option for founders looking to raise capital. It should also be something entrepreneurs consider when it comes to drawing attention and support for their projects. The key is choosing the right type of crowdfunding model, marketing the campaign well, and delivering on the promises made.