The Ultimate Guide to Crowdfunding
This content is for informational purposes only and not intended to be investing advice. It is educational in nature and not designed to be a recommendation for any specific investment product, strategy, or other purposes.
If you are looking to raise money for a business, or if you are thinking about investing in a company, you may have heard about crowdfunding. At the same time, you might be wondering what this is and how it works. Crowdfunding is exactly what it sounds like: a crowd of people individually invest small amounts of money to get an idea off the ground. Learn more about this concept below, and see if there are opportunities for you to get more involved in crowdfunding.
What is Crowdfunding
Crowdfunding takes place when a group of people, collectively referred to as the crowd, each donates small amounts of money to support a project. When the total amount of money is combined, there can be a tremendous amount of financial backing thrown behind a project.
Some crowdfunding activities are relatively minor. For example, a bunch of parents on a sports team may need to donate a few dollars to cover the travel expenses of their players. Crowdfunding can also be used to launch a small business, or for charitable endeavors. Think of thousands of people in a local community deciding to donate a few dollars each to help someone purchase a new car that was totaled in an accident. Of course, crowdfunding can also be used to launch a startup company or to raise money in an investment campaign.
How to Conduct a Crowdfunding Campaign
When a company or individual is interested in launching a crowdfunding campaign, there are several steps they need to follow. They include:
Select a Platform
The first step is to select a platform. Platforms come in many shapes and sizes. Some platforms may specialize in raising money for a specific industry, while other platforms might raise money for a wide variety of campaigns. Remember that platforms have specific rules, so it is important to make sure they allow that specific type of campaign. Finally, some platforms may take a percentage of the proceeds as a commission, so it is important for anyone looking to run a crowdfunding campaign to be familiar with the rules of that specific platform.
Wait for the Platform To Accept the Campaign
Most platforms vet every campaign before deciding to accept them. The platform needs to check and make sure the campaign is legitimate. There are typically online forms and documents that need to be submitted, and the platform may require a prospectus for an equity crowdfunding campaign. The prospectus details the investment, potential risk warnings, and any cooling-off periods that must be followed.
Make the Pitch
If the campaign is accepted by the platform, the person running the campaign is responsible for making a pitch. Potential investors will be curious about the project, how it works, why the funds are required, and how much the campaign is hoping to raise. In some cases, investors might actually be donors or sponsors, and they may receive some sort of award. Even giving donors a t-shirt or coffee cup can go a long way. Keep in mind that these items can double as marketing materials, as other people may see the t-shirt and become curious enough to invest or donate themselves. It is important to look at the pitch as a marketing campaign. This is an opportunity to make the project or business attractive to potential investors. The vast majority of campaigns will be posted on a variety of social media channels in an effort to convince people to donate.
Conduct the Campaign
Finally, the campaign can get going. There is usually a start date and an end date, but the end date is often flexible. Eventually, the campaign will end, and the company will collect whatever investments they have received. Then, they will be responsible for using their investments to try to generate a return for those who backed the campaign’s idea.
These are the general steps that crowdfunding campaigns need to follow. Keep in mind that the exact details will vary depending on the type of platform used, but the general steps are the same.
Why Crowdfunding: What Are the Benefits?
There are several potential benefits of running a crowdfunding campaign. They include:
First, lots of people like running a crowdfunding campaign because it is simply more efficient than running a traditional fundraising effort. When a company is in its earliest stages, it can be difficult to decide how to spend time. It takes a tremendous amount of time to apply for a loan or look for accredited investors. Instead, it can be faster to simply set up a crowdfunding campaign, put together a pitch, and hope that it is compelling for people to donate.
Build Social Proof
A refined crowdfunding campaign is also an opportunity to demonstrate social proof that is vital for getting a company off the ground. When potential customers donate to a crowdfunding campaign, it shows they are interested in what the company has to offer. This can act as social proof that the idea is solid, and it could inspire the founders to continue building the business. Eventually, this social proof translates into tangible traction, meaning that people are ready to purchase the product or service that the business puts out.
Collect More Ideas
Running a crowdfunding campaign is also an opportunity to collect more ideas. For example, people who donate money may provide ideas about how to build on the existing products or services provided by the company. It is possible that one of the donors may have an idea that could lead to more revenue for the company. Customer feedback is incredibly important at every stage of the business growth process, and it can be collected for free during the crowdfunding campaign.
Build Customer Loyalty
A crowdfunding campaign is also an opportunity to build customer loyalty. Even if the business doesn’t have any actual customers yet, people who donate to a crowdfunding campaign feel like they are a part of the company. They believe in the story of the company, the products or services the company provides, or what the company stands for. After all, they wouldn’t donate money to the campaign if they didn’t believe in the idea. They are key to the success of the company, and they are likely to become customers when the idea gets off the ground. They might also share the company’s idea with their family members and friends, who might be willing to donate as well.
Doubles as Marketing Campaign
Finally, a crowdfunding campaign also doubles as a marketing campaign. Even though it may cost money to get the crowdfunding campaign off the ground, it probably will not cost as much money as a traditional marketing campaign. The crowdfunding campaign may get a lot of social media and traditional media exposure as well, which can help the business reach more investors. Even a single mention on Twitter or Instagram can collect numerous donation dollars.
Ultimately, these are just a few of the many reasons why companies may decide to conduct a crowdfunding campaign.
The Different Types of Crowdfunded Investments
There are several types of crowdfunded investments. They include:
Real Estate Crowdfunding
Another common type of crowdfunding is real estate crowdfunding. It is similar to equity crowdfunding in that these platforms give investors an opportunity to purchase shares in a real estate investment fund. Someone trying to purchase real estate on their own can run into difficulties because it requires a tremendous amount of capital. Real estate crowdfunding platforms give people an opportunity to invest in real estate for a much smaller amount of money.
There are several ways real estate crowdfunding might be conducted.
- Someone can purchase shares in a real estate investment company. This is called direct equity.
- Another option is called preferred equity. In this situation, someone invests in real estate for a specific term. These funds pay their equity holders a preferred return either monthly or annually. Then, when the term expires, any profits from the real estate fund are distributed to its equity holders.
- Finally, there is a traditional debt option as well, which comes in the form of a mortgage. In this case, most debt is a short-term loan. It might be used for a development project, or it could be a property that is undergoing rehab. Then, when the property is sold, the profits from the project get distributed to the holders of the debt (the investors).
These are a few of the most common options in real estate crowdfunding.
Equity crowdfunding takes place when crowdfunders provide capital to a company in exchange for equity in the business. Even though this is usually a company in its early stages, such as a start-up, this is not always the case. Typically, someone who invests in an equity start-up will receive some sort of promise, such as a note agreement, that converts their condition into equity down the road.
The note is responsible for spelling out how the crowdfunded donation is converted. A few factors that will dictate this include:
- The valuation cap, which is the amount that can be converted into equity
- The interest rate, which is tied to the loan (but not always paid out, as investors are paid in equity instead)
- The term length, which is how long the company has to pay back the loan
- The conversion discount, which specifies the discounted rate at which the donors are allowed to purchase shares
This note is the most common type of equity crowdfunding, but there are nuances and changes that can be made to this process as well. For example, someone may donate to a company as a direct investment, meaning they are on the capitalization table. Or, the person donating money to the company might be given shares of the company, which is typically called a series round. It is also possible for someone to purchase equity in crowdfunded funds, which are usually ETFs or mutual funds.
Peer to Peer Lending
Peer-to-peer lending, which is usually abbreviated P2P, is the oldest type of crowdfunding investment. This is what people typically think of when they think about crowdfunding. Someone with an idea sets up a campaign on the platform. Some platforms have restrictions on what they allow people to raise money for, but people can raise money for just about anything. For example, someone might be looking to raise money for a home improvement project. Or, someone might be looking for a personal loan they can use to refinance student loan debt.
Essentially, someone is investing in a person instead of a traditional company. These platforms have different ways of vetting the financial risk of each campaign. Therefore, it is important to keep in mind that there is a possible risk of default, as there is no collateral with these campaigns.
Specialty Crowdfunding Investments
Finally, there are several types of specialty crowdfunding Investments as well. Essentially, anything that doesn’t fall into one of the three categories above qualifies as a specialty investment option. Instead of investing in a specific idea, most people are considered sponsors or buyers. Some people like to back a creative project in exchange for a physical good. Other people might invest in the inventory of a specific company. The idea is still the same. People are pooling their money together to back a specific project. At the same time, remember that there is nothing securing the investment, making it particularly risky. People who donate money to the campaign usually get some type of asset in return.
Understand the Different Types of Crowdfunded Investments
Ultimately, crowdfunding is a great way for companies, organizations, and individual people to raise money. This is also an opportunity for people to get involved in interesting ideas that are just getting started. Crowdfunding opens doors and opportunities for people who might not otherwise have any other options, and there are lots of niche platforms that focus on certain areas. It will be interesting to see what new ideas come from crowdfunding in the near future.
Any examples used in this material are generic, hypothetical and for illustration purposes only. Important regulatory considerations are applicable with crowdfunding, among them Regulation CF. You can find more information here.