What is crowdfunding and how does it work?

If your business needs cash but you don’t have the time (or qualifications) to apply for a traditional loan, you might consider taking your case to the people. Crowdfunding lets you bypass some of the gatekeeping associated with established lenders to get the money you need for your business, but it’s not for everyone. Here’s what you need to know about the risks and rewards of this fundraising strategy and how to get started.  

Crowdfunding is the process of getting a large pool of people to contribute small amounts of money to help fund your business or venture. Usually you don’t need to pay this money back, unless it’s a specific type of crowdfunding called “debt-based crowdfunding.” 

To kick things off, a business will typically launch a fundraising campaign on a crowdfunding platform. Typically, a business only has a limited amount of time to hit its fundraising goal, typically just 30 to 90 days. If your business doesn’t hit your fundraising goal in the specified timeframe, you won’t receive any of the money pledged to you.

Contributors to crowdfunding campaigns are usually accredited investors who choose to use their personal money to support different ventures. They often receive equity in exchange for their investment. 

Sometimes, platforms allow non-accredited investors to contribute small amounts of money to campaigns, usually in exchange for free merchandise or other perks instead of equity. 

You can choose from a  few different types of crowdfunding. Here’s a snapshot of what to expect from each method. 

Rewards-based crowdfunding

Contributors to a reward-based crowdfunding campaign usually receive some kind of perk in exchange for their financial support. This could be branded merchandise, special discounts and memberships, free products and more. 

Usually, contributors to a rewards-based crowdfunding campaign are not accredited investors.

Equity-based crowdfunding

Equity crowdfunding is where individuals (usually accredited investors) contribute money to a business in exchange for potentially one day gaining a small ownership percentage in the business. This is usually done through a crowd SAFE (Simple Agreement for Future Equity). A crowd SAFE investment converts to stock in the company or cash when certain events occur, like if/when the company is acquired by another business or it has an initial public offering (IPO) on the stock market.

There is no guarantee that a business will get acquired or make an IPO, which means investors may not see a return on their contribution.

Equity-based crowdfunding is more suited to startups that want to grow quickly and need regular infusions of capital from investors. If your business is an ice cream shop, a bookstore or any other operation that can quickly make enough revenue to avoid having to take on investors, then you probably want to avoid sacrificing equity with this form of crowdfunding.

Debt-based crowdfunding

Debt-based crowdfunding involves a business crowdfunding a loan from a pool of investors and individuals. This type of crowdfunding is sometimes also referred to as peer-to-peer lending. Unlike the other forms of crowdfunding, you do have to pay back money (often with interest), similar to the way you would repay a traditional loan from a bank or credit union. One advantage debt-based crowdfunding has over those loans is that you can avoid the qualification criteria used by traditional lenders.

Donation-based crowdfunding

Perhaps the simplest form of crowdfunding is donation-based crowdfunding, which allows individuals to contribute money with no expectation of a return on investment (ROI) or any perks.

Why would anyone support a company without receiving a tangible reward? Simply because they believe in the founder’s cause or service. Nonprofits or businesses aimed at solving social problems can sometimes rely on a passionate audience to make donation-based crowdfunding a success. 

Founders who use the donation-based crowdfunding strategy don’t have to give up any of their equity and don’t need to repay the funds they raise.

If your business hasn’t been around long enough or earned enough revenue to qualify for a traditional business loan from a bank, crowdfunding can serve as a solid alternative for raising money. Additionally, rewards-based crowdfunding could be most appealing to small business owners who don’t want to give up any equity and can’t afford to pay back a large loan or use debt-based crowdfunding. But beyond those practical reasons, crowdfunding can help your business in ways a loan can’t.

For example, because crowdfunding exposes your business to a large audience, it can also serve as a barometer for your future business success – if you can’t hit a fundraising goal, it could be a sign that the demand for your business isn’t where it needs to be. 

The exposure you get from a crowdfunding campaign also increases awareness of your brand, so if you haven’t launched yet this is a great opportunity to get people excited for your product. And even if your business is up and running, a rewards-based crowdfunding campaign can help drum up enthusiasm for a new offering from your company.   

Keep in mind that you typically only have a few months to reach your fundraising goal when crowdfunding. If you don’t hit your goal, you don’t get to keep the funds you did raise. While crowdfunding platforms expose your business to a huge audience, you might often have to market your campaign to your friends and family to gain as much traction as possible.

Before choosing a platform for your crowdfunding campaign, you’ll want to consider the type of crowdfunding campaign you’re pursuing as well as understand the fees each platform charges.

Kiva is a debt-based crowdfunding platform that allows businesses to raise their own microloan. Businesses can fundraise up to $15,000 through Kiva. And because Kiva is a nonprofit, you’ll pay 0% interest on the loan.

You may likely already be familiar with some popular donation-based crowdfunding platforms — GoFundMe is one of the most well-known ones. It’s free to create a campaign on GoFundMe, but the platform automatically deducts a fee of 2.9% + $0.30 per donation. This means that you don’t get the entire amount that you fundraise, but you also don’t have to worry about paying a fee out of pocket.

Indiegogo and Kickstarter are good places to start if you’re interested in a rewards-based crowdfunding campaign. Keep in mind that they both collect a 5% fee if you reach your fundraising goal, but they won’t charge a fee if you don’t. Like GoFundMe, Kickstarter and Indiegogo may charge a fee for every contribution made to your campaign.

If you can’t afford to use your personal savings to fund your business and don’t have the time to wait around on a crowdfunding campaign, there are still a few other options to consider when funding your business.

One of the most common ways to fund a business is through a small business loan. You can typically apply for up to $500,000, but some lenders may offer as much as $1 million in funding to qualified applicants.

Credibly offers small business loans of up to $600,000 and for the most part, they consider credit scores as low as 500.

Fora Financial, though, offers loan amounts as high as $1,500,000 and can get you funded in approximately 48 hours, according to the lender’s website. Most business loan lenders have strict requirements in order to qualify for a loan. Fora Financial and Credibly require you to be in business for at least six months and have a monthly revenue of at least $15,000. 

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