What is Crowdfunding
As technology advances, business owners are quick to incorporate the newest technology within their business practices. This change is evident in the way we communicate with clients and the way we conduct business. The rise of social media has been one of the biggest game changers; business use social media to constantly stay in contact with clients and potential clients, share promotions, market products and services, and offer a vehicle for communication between client and business.
As social media’s presence in the business world grows, terms like “crowdfunding” get tossed around more frequently, especially on platforms like Facebook where friends can easily share campaigns. We see the campaigns, but do we really know what crowdfunding is? Crowdfunding is becoming more popular and visible (thanks to the Internet), and is changing the future of business. It’s important to understand exactly what it is and how it benefits our communities.
First, what is crowdfunding?
Crowdfunding, in its most basic form, occurs when a business venture is funded, not by one lender or investor, but through several smaller investors. The first, and perhaps the most surprising fact, is that crowdfunding is nothing new. In the late 1700’s, Alexander Pope used crowdfunding to finance a major translation of six volumes of Homer. In return for a small investment, the investors received their name inscribed within the book.
This is a stark contrast to the traditional business practices of financing business ventures. Usually, a business owner prepares a business plan to present to a small number of investors; the owner then presents his (or her) pitch to the investors, asks for a large sum of money, and demonstrates how the investors will make a return on his (or her) investment. Simply look to ABC’s Shark Tank to see what this type of investment looks like; the entrepreneur states their business type, what they need money for, how much capital they seek, and how much equity they are willing to give. Sometimes the capital received is in the form of a loan, which then requires terms of a loan to be finalized. If the sharks don’t bite, no deal is struck.
In stark contrast to the typical investor scenario is crowdfunding. Where traditional investing involves large sums of capital from a few investors (or a loan from a bank), crowdsourced funding entails small amounts of capital from hundreds of individuals. Today, this type of investing can be demonstrated through events like benefits, galas, and fundraisers. There you have several investors donating smaller amounts of capital to the cause or business venture. Hospitals frequently employ this type of event to raise money for new hospital wings or research. Supporters and investors frequently are “rewarded” for their donation by having their name inscribed on a plaque or having a wing of the hospital named in their honor, similar to Alexander Pope’s list of “subscribers” in his translated works.
The integration of the internet and social channels with crowdfunding techniques has transformed crowdfunding from a localized event (like a hospital fundraiser) to a global event (with supporters from multiple states and countries). Crowdsourcing platforms allow business to create their “pitch” (i.e. a video) and share with potential clients. Like the hospital galas, investors also receive rewards for contributing. The more an investor contributes the better and more enticing is the reward. For instance, a new band might offer a digital copy of a single hit for a donation of $5, but the reward for a $200 donation is a signed copy of the latest album and a ticket to their next concert. The increasingly superior rewards are an incentive for a potential customer or backer to level up.
Why does it work? How is crowdfunding a successful option for raising capital?
According to Forbes Magazine, successful crowdfunding campaigns experience two phases. First, the venture is backed by the campaign creator’s close friends, family, and aquantices. Approximately 25-40% of the investment is received in this phase. As the campaign grows, in part to the participation of the close friends and family, potential investors, unknown to the creator, emerge and invest. The integration of social media is to thank for the ease and speed with which a crowdsourced campaign can gain turf and reach more potential investors and customers.
Indeed, it is after the friends and family have contributed and shared the campaign via social channels that the campaign begins to gain an online presence. However, merely having a crowdfunded campaign online does not guarantee that anyone will contribute to the cause. The most successful crowdsourced campaigns were proactively managed e.g. the product was presold through a well-maintained email list. An email list or an active social platform is a powerful tool for gaining investors outside of the family and friends circle. The “stranger” investor is what separates an okay campaign from a very successful campaign, which leads to the next aspect about learning about crowdfunding.
Why do investors and potential customers choose to back a campaign?
We know why Uncle Bob contributes to your campaign, but what makes a perfect stranger decide to invest in your business? Investors decide to contribute to your campaign for two main reasons: 1.) They feel strongly about your venture and/or 2.) They desire the rewards attached to investing.
Choosing the right rewards has two perks. First, investors are drawn to promising rewards, usually a pre-market product; good investors like to be involved in “the next big thing” from the start. Offering a pre-market product entices prospective investors to jump in. Second, by offering your product (or a sample of it) as a reward, the campaign creator is able to test the market and gauge the potential success of the product itself.
Because you cannot make a personal pitch to each person who comes across your profile page of the crowdfunding platform, your video and profile must be the pitch. It has to grab their attention, relate pertinent information, and make the viewer want to contribute. Therefore, the video aspect of crowdfunding is the most crucial hook for a viewer to connect to your cause, your mission, your business. It is what keeps a viewer on your page rather than scrolling along to view another campaign.
Investors choose to invest because crowdsourcing is a safe and reliable way to invest money. Crowdfunding is not a hand-out or a scam. It is a legitimate and alternative option to finance a business venture. Verified crowdfunding platforms have guidelines and procedures in place to prevent a crowdsourcing platform from deviating from anything short of authentic. For instance, certain crowdsourced platforms are “all or nothing” – which means that if you need $10,000 to launch a new shoe company but only $7500 is pledged, your campaign failed and you don’t receive any of the pledges. This prevents the campaign creator from being in the awkward and seemingly impossible situation of trying to accomplish a 10K project with only 75% of the funds. The “all or nothing” mindset helps eliminate some risk (and there’s always some degree of risk) with a new product or venture; in the long term, reduced risks encourages more investments.
Who uses crowdfunding? Isn’t just for startup businesses?
Crowdfunding, when used correctly and marketed well, can be a profitable tool for startup, fledgling, and previously established businesses. For instance, a startup beauty company can create a campaign to raise the capital needed to buy inventory and successfully launch a web-based business. In this case, the crowdfunding gives the business the boost it needs – a boost that is sometimes difficult to attain with business loans. Banks are cautious when working with startups as there is often little evidence of cash flow. A small caveat: while small businesses and startups have been born out crowdfunding, campaigns usually do better when the campaign creator works actively to make the campaign visible, especially through social channels. Passivity does not make for a successful crowdfunding campaign.
Established businesses also benefit from crowdfunding. In a 2013 Entrepreneur article, Vanessa Richardson explores this benefit: crowdfunding promotes product viability and created an instant customer base. This alone may be the single best benefit of crowdfunding; more than acquiring capital, crowdfunding offers business owners invaluable information. Will a product be successful? Are investors and potential customers excited by the new product? Crowdfunding is like a focus group, offering insights that may ultimately be the key to success.
How does crowdfunding affect me?
In short, crowdfunding improves our communities by boosting the economy. As businesses gain the neccessary capital they need to grow and thrive, the customer bases expands, leading to higher profits. With more money filtering into the growth of businesses, more jobs are created, more revenue comes in, and the cycle continues.
So, what is crowdfunding?
Crowdfunding is a way to raise capital, relying on numerous backers to offer support. With roots deeply embedded in history, crowdfunding has withstood the test of time, and just might be the key to the success of your next business venture.