Updated onSeptember 18, 2022

What Is Crowdfunding & How Does It Work ?

12 Min Read

Difficulty:easy

Written by:**TJ Porter**
Personal Finance Writer

Reviewed by: Kal Salem, MA Accounting - Arizona State University

Fact-checked by: Somer G. Anderson, PhD Finance - Maryville University

All content presented here and elsewhere is solely intended for informational purposes only. The reader is required to seek professional counsel before beginning any legal or financial endeavor.

The definition of crowdfunding is acquiring small amounts of money from a large number of everyday people to finance a new business or product. In return for their small amount of investment they will either receive the new product before anyone else, a small percentage in the business or have no expectations for a return at all.

How Does Crowd Funding Work?

Crowdfunding lets companies raise money from everyday people instead of working with angel investors. You might wish to explore what are angel investors.

Typically, you put together a video or text-based presentation outlining your company, what you want to do, how you plan to do it, and how much money you need to meet your goal. You can post your campaign on a crowdfunding website and that site’s users can help fund your goal.

Most crowdfunding campaigns involve incentives for funders. For example, you can use a crowdfunding campaign to pre-sell products before you produce them or offer perks like VIP events to top funders.

One of the top-funded crowdfunding campaigns of all time raised more than $41 million for author Brandon Sanderson to help him publish four novels. Backers who provided certain amounts of funding received the books in audiobook, eBook, or hardcover format.

It’s easy to get started:

Be at least 18 years old
Have permanent residency or citizenship in the US
Have an address and bank account information to receive funds

What Types Of Crowd Funding Are There?

There are many different crowdfunding types out there. Some of the most popular include:

Donation-based crowdfunding. In this model, backers simply donate funds to you because they like your idea and want to help you succeed.
Rewards-based crowdfunding. Perhaps the most popular model. With rewards-based crowdfunding, backers provide money in exchange for rewards, such as the campaign described above. This is the model used to pre-sell products.
Equity-based crowdfunding. Some companies use crowdfunding to sell equity in their company.
Peer-to-peer lending. With peer-to-peer lending, you can borrow money from regular people. Keep in mind you’ll have to pay it back. See what is peer to peer lending for more details.
Human capital crowdfunding. With this model, funders help your company grow using their specialized knowledge or skills.
Debt-securities crowdfunding. Like P2P lending, this model involves issuing debt securities to borrow money from funders.
Hybrid models. Some crowdfunding campaigns use a mix of these models. For example, a campaign might use rewards-based crowdfunding but accept smaller donations from those who simply want to show their support.

Be bold - you’ll see it works once you start...

What Is A Crowd Funding Campaign?

A crowdfunding campaign is a way for businesses, individuals, or other organizations to raise money. Typically, these campaigns happen online through a specialized fundraising site.

The goals of crowdfunding campaigns can vary. Some people use them to raise money to pay for medical bills. Aspiring business owners use campaigns to help get their company off the ground. Others use them to fund the production of specific products.

Online campaigns typically rely on storytelling and visuals to make their campaigns more appealing. For example, one campaign to produce a protective case for trading cards showcases the designer’s history with and passion for the cards to draw people in.

Who Is Crowd Funding Recommended For?

Crowdfunding can be a good idea for many types of people, including:

Entrepreneurs. If you need funds to start a new company, a crowdfunding campaign is one option for raising money. New entrepreneurs may also want to look into what is a microloan.
Small business owners. Small businesses can use crowdfunding campaigns to ask loyal customers to help fund a move to a new location, the addition for a new product line, or other expansions. Funds raised through crowdfunding could also be used to secure working capital for businesses.
Activists. Activists can use crowdfunding to get support from people sympathetic to their cause.
Philanthropists. Crowdfunding campaigns are a good way for people to raise money for good causes, such as providing clean water to a remote village.
People in need of medical assistance. People facing large medical bills often turn to crowdfunding for help with the cost of care.
Researchers. Crowdfunding can help scientists raise cash to pay for research that they want to perform.

Where To Look For Crowd Funding Opportunities?

As crowdfunding has grown in popularity, many different platforms for crowdfunding have appeared.

GoFundMe. GoFundMe is best for individuals looking to raise money. It’s a popular site for medical crowdfunding and raising funds for other personal purposes.
Classy.org. This crowdfunding site focuses on nonprofit organizations and helps them build relationships with donors.
Indiegogo. One of the oldest crowdfunding sites, Indiegogo is a great choice for entrepreneurs and investors.
Kickstarter. Possibly the best-known crowdfunding site, Kickstarter is a popular platform for individuals and businesses looking to raise money to create specific products.
StartEngine. Founded in part by a host of the TV show “Shark Tank,” StartEngine helps small businesses sell equity in crowdfunding campaigns.
Patreon. A less traditional crowdfunding site, Patreon lets people subscribe to creators to provide them with consistent support and help them afford to continue their projects.

How To Choose The Right Crowd Funding Platform?

Choosing the right crowdfunding platform is an important part of your campaign’s success. You have to consider what users of that site expect from campaigns as well as other factors, including:

Credit processing fees. If backers want to provide funds with their credit cards, how much of their funding will go toward fees? The less you pay, the better.
Platform fees. Some platforms charge a fee to use their site. The lower the fee you have to pay, the more money you’ll keep to fund your project.
Ease of use. Make sure the platform you select is both easy for you and easy for backers to use.
Customization. One of the most important aspects of a campaign is how you tell your story and lay out your idea. You want to use a platform that lets you customize your campaign to be appealing to backers.
Customer service. Good customer service is essential whenever you’re dealing with money, so make sure it’s easy to get help when you need it.
Educational resources. Some crowdfunding sites have valuable resources you can use to make your campaigns more effective.

The benefits of crowdfunding include:

Access to capital for new businesses. Anyone can start a crowdfunding campaign, which can help you start your business.

Increasing awareness for companies, brands, products, services, and social problems. Crowdfunding sites let you tell your story, which can help you raise awareness for your cause.

Validation of concept and market testing. A small crowdfunding campaign can help you test an idea or market to see if it’s worth expanding into.

Raising funds quickly. If you need cash quickly, crowdfunding campaigns can be faster than traditional fundraising.

PR & Marketing opportunities. Crowdfunding sites often promote projects, giving you some extra PR and marketing support.

The disadvantages of crowdfunding include:

Time-consuming. Building a good crowdfunding campaign can take time and there’s no guarantee that yours will succeed.

Oversaturated market. There are so many crowdfunding campaigns these days that it’s easy to get lost in the shuffle.

Prone to scams. Those funding campaigns may be wary of scams and have to deal with the potential that the companies raising money might not deliver on their promises.

Requires resources for promotion. To build a successful campaign, you need to put in the effort to prompt it.

Potential for no to little gain. If you can’t draw funders, you might put effort into your campaign for no return.

I Want To Invest In Crowd Funding - What Should I Know?

If you’re thinking about investing in crowdfunding, there are a few important things to know.

Crowdfunding is generally very accessible. You can fund a campaign in minutes. Depending on the amount you invest, it can also be low risk. However, it’s important to do your due diligence on the companies you invest in to make sure they're legit.

To give yourself the best chance for success, invest in multiple campaigns and use crowdfunding as a way to diversify your portfolio rather than your main investment strategy.

Breath - It looks like a mountain but once at the top, you’ll see it's a hill...

Tips For Successful Crowd Funding

If you’re using crowdfunding for your business, you can use these tips to give yourself the best chance of success.

Research the market before launching your campaign. Make sure you know the risks and opportunities in the market and address them in your campaign.
Ensure enough time, resources, and manpower. If you’re promising something to backers, such as shipping a product, make sure you have the time and resources to deliver on your promises.
Communicate with supporters. The more you communicate with backers, the more goodwill you earn, which can help you with future campaigns.
Try to get good press. Advertising your campaign can be hard. If you have a way to draw in press coverage, that can serve as free advertising to draw in more funders.
Support others in your industry. If you build connections with people in your target industry, they may be willing to help your campaign and you’ll naturally build some brand awareness.

Examples Of Successful Crowd Funding Campaigns

Crowdfunding has seen many success stories over the years. Some examples of good campaigns include:

Glowforge. This campaign raised nearly $28 million in thirty days. The funds helped the company create an advanced 3D printer for home use. Unusually, the company uses its own site to host the campaign rather than an established platform.
Pebble. Pebble raised more than $20 million from backers to help produce a line of smartwatches. The campaign utilized multimedia and emphasized the flexibility of the device.
Coolest Cooler. Entrepreneur Ryan Grepper used a campaign to raise money to produce and sell a cooler that featured accessories such as a blender, Bluetooth speaker, USB charger, and more.

Resilience is what you need - you will succeed if you keep going...

Alternatives to Crowd Funding

Crowdfunding isn’t the best choice for every business. You might want to consider alternatives if you aren’t trying to pre-sell a product or need to raise more than you can typically get from crowdfunding.

If you’re raising money for a company, consider these other options.

Angel investors. These investors are wealthy individuals or companies that try to invest in startups. They use a high-risk, high-reward strategy and may be willing to invest large amounts. Some angels can also assist your company with their personal brand, expertise, and connections.
Business loans. You might consider borrowing money to start a company, especially if it’s on the smaller side. A personal loan, a business loan from an online lender or a Small Business Administration loan can be a great way to get off the ground.

Final Word

Crowdfunding is an exciting field that gives individuals, companies, and entrepreneurs a new way to raise money. While it differs from traditional funding methods, you still need a strong pitch and a way to differentiate yourself from the thousands of other campaigns out there. To succeed, make sure you prepare before launching the campaign and put in sufficient effort.