What is Crowdfunding and How Does it Work?

Are you considering crowdfunding to finance your business? While it may seem fairly straightforward, it’s worth walking through the basic setup and operations process—as well as understanding what happens if you don’t reach your funding goal. 

Let’s walk through how crowdfunding works and what to look out for when using specific platforms.

What is crowdfunding?

Crowdfunding is a financing method where entrepreneurs raise small amounts of money from a large number of people, typically via the internet. It enables startups or other enterprises to access capital through specific platforms that connect them with potential investors, donors, or contributors. 

The funds raised can be used to kickstart a business, launch a product, or support specific projects. This method also provides an opportunity for the crowd to participate in the entrepreneurial journey, either as equity stakeholders, lenders, donors, or early customers.

How does crowdfunding work?

Remember that crowdfunding is a public effort. Transparency, regular communication, and gratitude to your backers are key to running a successful campaign. Here’s how to get started:

1. Land on an idea

The process starts when you decide to pursue a project or business idea that requires funding. This could be a new product, a business venture, or a unique initiative. At this point, you should have at least a one-page business plan written and a rough idea of how much money you need to get started.

2. Choose a crowdfunding platform

The next step is to select a crowdfunding platform suitable for your project’s needs. Popular platforms include Kickstarter, Indiegogo, and GoFundMe for product or project-based campaigns, and AngelList or SeedInvest for equity crowdfunding.

3. Set a funding goal

After choosing a platform, set a funding goal. This goal should cover the cost of the project while also accounting for the fees of the platform and other expenses. Again, you can use your business plan (specifically your financial plan) to help map this out.

4. Create a campaign

You’ll then need to create a crowdfunding campaign. This involves writing a detailed description of the project, outlining the budget, and explaining how the money will be used. Visual aids, such as videos or images, can also help you better engage with potential contributors.

5. Select and offer rewards

For many types of crowdfunding, you’ll need to offer rewards to backers. These rewards vary based on the amount contributed and can range from a simple thank you note to early access to the product or service.

6. Promote the campaign

Once the campaign is live, you need to promote it. This may involve social media marketing, email newsletters, public relations efforts, and any other marketing efforts that get you in front of your target customer.

7. Receive funds

If the campaign is successful and reaches its funding goal, the platform will transfer the funds to you after deducting a service fee. You can then begin to implement the project with one caveat.

8. Deliver rewards

Before you can start using the funds to grow your business, you need to first deliver the rewards to your backers. This may require you to produce products exclusively for these early customers, or in the case of equity crowdfunding, it may involve distributing shares or providing regular updates on the company’s progress.

What if you don’t reach your funding goal?

What happens if you don’t reach your crowdfunding goal depends on the platform and type of crowdfunding campaign you’ve chosen to run:

All-or-nothing (AoN) campaigns

Some platforms, like Kickstarter, operate on an all-or-nothing or fixed funding model. If you don’t reach your set goal, all funds are returned to the contributors and you receive nothing. This model protects backers, ensuring their money is only used if the project can proceed as planned.

Keep-what-you-raise (KwYR) campaigns

Other platforms, like Indiegogo, offer a flexible funding model where you keep whatever funds you raise, even if you don’t meet your goal. However, these platforms may charge higher fees if you don’t reach your target.

Equity Crowdfunding

In equity crowdfunding, you generally need to reach your funding goal to receive the investment. If the goal isn’t met, the pledged funds are usually returned to the investors.

Learn more about crowdfunding your business

Hopefully, you now have a solid understanding of how the crowdfunding process works. Remember, if you don’t reach your goal, it’s essential to communicate and be transparent with the backers or investors and explain what will happen next. Ideally, you’ll choose to learn from the experience, refine your project or campaign, and try again.

For more expert insights and guidance around this type of funding check out our Guide to Crowdfunding. And if you’re ready to just dive, take a little time to reflect and determine if crowdfunding is truly the best funding option for your business.