What is Crowdfunding and How Does It Work?

What is Crowdfunding and How Does It Work?

What is Crowdfunding and How Does It Work?

In the Digital Age, business moves fast, and new innovations seem to be revolutionizing the business world every year. But while gimmicks and neat new concepts will come and go, one modern innovation has the potential to change everything about venture capital, investing and small business. That innovation is the idea of crowdfunding, and it is already having a big impact on entrepreneurs, investors and new business.

What is crowdfunding?

In its simplest form, crowdfunding is a way for startups to secure funding through the collective investments of individual people. While that may not sound like a revolutionary concept, social media and online platforms are providing a completely new way for potential business owners to pitch their ideas to a large number of people and gain the necessary capital to get off the ground.

This is important for startups because it is essentially the complete opposite of traditional methods for funding their business. When using traditional routes, an entrepreneur would need to develop his or her business plan and pitch it to a select few wealthy investors, one at a time. These traditional sources include venture capitalists, business loans and angel investors, and assuming you did not receive all of necessary funds in the first pitch, you may need to visit several sources, tailoring each pitch and strategy to each potential investor.

Crowdfunding essentially turns the entire process upside-down. Instead of hunting for individual investors and making several different pitches, you would use a crowdfunding website to make one pitch and (hopefully) let the investors come to you. Investors search through the various new ideas, inventions, concepts and startups to find one that they feel is worth their investment.

How does crowdfunding work?

Of course, while crowdfunding is a great alternative to traditional methods of gaining capital for your startup, the money does not come for free. There are essentially three main types of crowdfunding, and the major differences lie in the returns expected by investors.

Donation-based

Actually, with this type of crowdfunding, the money almost does come for free. Aside from the fee charged by the crowdfunding website (which can be sizeable and is nothing to ignore), investors in this type do not expect to gain anything back from the money they put in. However, this technique is generally used only for nonprofits, charities, disaster relief and other such initiatives.

Rewards-based

With this type of crowdfunding, those who invest in your new business do not necessarily expect a monetary return on their investment, but the return will come in the way of a specific benefit, product or reward from your company. This could be an advance release on your new video game, a pre-sale for your new kind of soap, special access to your new marketing concept or any other type of reward that people deem to be worth their investment.

Equity-based

Equity-based crowdfunding is more similar to traditional funding methods for startups. With this type, investors contribute to your startup and become equity owners in your new company. This will provide them with a financial return on their initial investment, as your business becomes profitable. This type of crowdfunding is limited to accredited investors and is generally used to gain larger amounts of capital. The amount could range anywhere from $50,000 all the way up to $10 million.

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Benefits of crowdfunding

Benefits of Crowdfunding

This concept is already revolutionizing investments in small business, and it is only going to grow in the future. It provides investors an opportunity to scroll through thousands of potential investment ideas and decide which ones may be worth their money. For entrepreneurs, there are even more meaningful advantages, including:

A large scope of potential investors
The efficiency of only creating one pitch for the world to see
Combining marketing with your funding by letting the world know about your business
Validating your idea through monetary investments and feedback from investors

However, it is not without its downsides, as crowdfunding is still developing as a funding method. The fees charged by platforms and websites can be sizeable, and there is no timetable for your investments to come through. It will be up to you to decide if the benefits outweigh the drawbacks, but crowdfunding should definitely be a consideration when starting your business.

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