Crowdfunding is actually a way to get small profits of money from a good number of people to create funding for a specified project. It’s existed for quite a while in the form of small donations for arts as well as community campaigns, in return for token incentives for example t-shirts or even dinner with the co-founders.
The CROWDFUND Act, passed by the President on April 5, 2012, now makes it possible for crowdfunding to be used by for-profit producers – as a result, a start-up that needs funds to expand its company can now turn to everyday people. The investors can collect equity, i.e. a “share” of possession in the company, or shares, i.e. offering a compact line of credit to the enterprise, according to what the start-up decides to provide you with. Large-scale crowdfunding was not formerly permitted under federal securities regulations. In wide terms, selling an interest in your business is the sale of securities, and any offer or sale of securities has to be registered with the SEC (e.g. in an IPO ) or designed to fit one of the exemptions from registration, that is very narrow ( and primarily for certified investors, i.e. rich individuals ).
The traditional pattern of financing for enterprisers begins with the entrepreneur maxing out her own credit car, then getting “friends and family” funding, before moving on to “angel” backing ( having a rich person support your company in return for an interest in it, bank loans and capital from venture capitalists ( private funds that offer money and advice to startups in exchange for some ownership in the company. Crowdfunding expands the “friends and family” stage. Now, along with friends and family, everyday people unknown to the entrepreneur can invest small amounts in their enterprise and receive a debt ( loan ) or equity ( ownership ) stake in the business in return.
There are numerous donation crowdfunding platforms where entrepreneurs can safely ask for capital such as Kickstarter, IDIDIT Foundation, and Indiegogo, to name a few. While each site offers its unique spin, the general concept is the same across the board. Project creators can create a profile typically containing a short video, an introduction to their project, a list of rewards per donation, and some images to elaborate. The idea is to create a compelling message that readers will be drawn towards.
Exactly why would entrepreneurs want to give up even a small amount of the control of the company to people they don’t know, who most likely can’t help them much with guidance and experience the way angel and VC investors can? For some businesses, it’s the only way to get the “seed capital” to develop their idea enough to get to the stage where angels and VCs will take notice of them. Other companies may be in areas of the country where it’s hard for start-ups to stand out from the crowd. And many entrepreneurs can be found in communities that have not been well-served by traditional banking and capital markets.
This is a revolutionary and exciting form of making an investment. Nevertheless, it is also high-risk. A lot of startups don’t succeed.
Instead of traditional investors, crowdfunding campaigns are funded by the general public. Typically, most successful startup fundraising efforts receive about 25-40% of their revenue from their first, second, and third-degree connections. This could include friends, family, work acquaintances, or anyone that the owner is connected to, including their second and third-degree connections. Once a project has seen some traction, unrelated consumers start coming out of the woodwork to support campaigns they believe in.
So just why would anyone invest in crowdfunding? The worst reason would be because you think you are going to make a lot of money. For a start, you can only invest a small amount of money through crowdfunding. Normal folks are limited to $2,000 a year. Even the richest among us can only invest $100,000. Even if you think you’ve identified the next Facebook, after further rounds of financing ( and the “dilution” that entails ) and the length of time it takes to get a business to the IPO stage, a crowdfunding investment isn’t going to change your life. The best reason to make a crowdfunding investment is that you really love the idea the entrepreneur is introducing, or you’re a fan of the product or service, or you believe in the entrepreneur himself, and you want to give them a shot at making it. The best reason behind making a crowdfunding investment is to give someone else the opportunity to change their life.