The Benefits (and Downsides) of Crowdfunding

What Is Crowdfunding?

Internet-based crowdfunding has become a popular tool in the world of fundraising (both for new products and for social causes) and product marketing. Crowdfunding refers to efforts to fund projects, ventures, and causes by relying on relatively small contributions from a relatively large number of donors using the Internet, independent of traditional financial and investment intermediaries. The utility of crowdfunding platforms lies their convenience, the ability to reach large numbers of potential donors, and the way they can provide support for the validity of a particular project. A successful crowdfunding campaign not only provides seed capital to its backers but also proves to larger investors and to vendors that there is ample consumer interest for the product. It can also serve as a way to sell the new product to the public without going through traditional retailers.

Kickstarter is one of the premier crowdfunding platforms. According to The New York Times, Kickstarter is one of many crowdfunding platforms for gathering money from the public which circumvents traditional avenues of investment like Initial Public Offerings (IPOs) or angel investors and venture capitalists. The company has led to $3.5 billion in funding from almost 140,000 projects from more than 14 million backers according to their website.

There are a number of methods crowdfunding platforms use to raise money:

Donation-Based Crowdfunding

Sites like GoFundme and YouCaring are popular donation-based platforms where there is no financial or material return for contributors. Common donation-based crowdfunding initiatives include fundraising for disaster relief, charities, nonprofits, and for personal medical bills.

Rewards-Based Crowdfunding

Rewards-based crowdfunding involves individuals contributing to a business or organization in exchange for a reward. Even though this method offers backers a physical reward, there is no financial or equity return on investment. Sites like Patreon and Kickstarter use this framework; Kickstarter and Indiegogo is popular among entrepreneurs launching new products and Patreon is often used by online content creators. Kickstarter rewards may be in the form of the product or service the campaign is intended to fund. Smaller donors may get a knick-knack or other small gift, while donors contributing large amounts may get multiple examples of a product. Groups on Patreon may give more varied rewards (as befits Patreon’s status as catering to creative types), maybe consisting of a piece of artwork or a mention in a YouTube video.

Equity-Based Crowdfunding

Unlike the donation-based and rewards-based methods, equity-based crowdfunding allows contributors to become part-owners of a company by buying equity shares, just like traditional stock sales. As equity owners, contributors receive a financial return on their investment and ultimately receive a share of the profits in the form of a dividend or distribution. EquityNet engages in this type of crowdfunding, and specializes in small business investing, EarlyShares finds investors for real estate.

 

How is Crowdfunding Different from Traditional Investing?

Crowdfunding is markedly different from the traditional approach to financing a cause or idea in a few distinct ways. Traditionally, if a person wants to raise capital to start a business or launch a new product, they would need to developed a business plan, do market research, and then market their idea to a relatively small pool of traditional investors. If someone wanted to raise money for a cause, they would likely need to become involved with a traditional charity (which often raise money by cold-calling and through mailings). If someone wanted to raise money to cover unexpected personal expenses, they would have to appeal to friends and family for that money. Crowdfunding allows project creators to go around these traditional methods. However, this can lead to problems.

The Downsides of Crowdfunding

Circumventing traditional fundraising channels can occasionally lead to scams or other fraudulent behavior. There have been multiple examples of Kickstarter projects that took their backers’ money and ran, and other projects that simply fell apart due to the inability of the backers to see them through. There is the possibility that individuals running crowdfunding campaigns for charity could pocket the money intended for charity, and there have been reports of scams targeting people raising money for personal expenses.

Crowdfunding can be a novel way for people to become involved in the creation of an exciting new product, to support artists and creators, or to donate to a cause that is important to them. But consumers thinking of donating to one of these campaigns should be aware of the risks involved. Donors may never get the product promised, or it could take much longer than expected. While many project operators are honest, this is not always the case.

Copyright for Image: Photographer, Stock Photo, License Summary.

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