What is Crowdfunding and How it Works?

Crowdfunding can be a daunting process, but understanding how it works and its different forms can make the process a lot easier.

What is crowdfunding?

Crowdfunding is the term that refers to “participatory financing”, a practice of raising funds by involving a large number of people. There are many different forms of crowdfunding, and they are usually accessible through an Internet platform that specializes in one or another form.

Unlike classic fundraising that involves going through a bank, crowdfunding collects several small amounts of money, thus contributing to the realization of a project or the financing of a company. It is also a very good way to publicize a new product or service but can also gauge the level of interest it may generate among the public.

How does it work?

Imagine that you have found a great and revolutionary idea to launch a new product. Everything is very clear in your mind, and you cannot wait to start it up to the point of jumping all over your living room like a kangaroo on ecstasy, but you have absolutely no money to start producing or even designing it. So, you go on a crowdfunding platform to present your product and explain why it is so awesome. You will also indicate the amount you need to be able to start the project as well as a deadline of the fundraising.

Internet users who are interested in your idea will then decide (or not, depending on whether you were convincing enough or not) to participate in its financing by paying the amount they want. A counter, which you will certainly consult every 10 minutes, will be displayed on the page, thus reflecting the volume of contributions collected and especially the amount it still lacks to achieve the goal.

If the amount you requested is reached within the deadline, the money will be paid to you and users will receive “rewards” (or not, depending on the type of crowdfunding chosen).

Is crowdfunding new?

Absolutely not. In 1875, the Franco-American Union had already organized a collection of funds from individuals to finance the construction of the famous New York Liberty statue. But it is from the arrival of the Internet online platforms based on this principle of participatory financing have started to emerge.

The statue of liberty, in New York Photo by Guilherme Bustamante on Unsplash

Initially reserved for artistic and charitable domains, they then quickly diversified, and today some of them are even addressed to very specific sectors such as the press, science, or real estate. The first crowdfunding Internet platforms to emerge were DonorsChoose in 2000, GlobalGiving in 2002, ArtistShare in 2003, My Major Company created in 2007, IndieGoGo in 2008, and Kickstarter in 2009.

What are the different forms of crowdfunding?

The forms of crowdfunding tend to diversify more and more, but overall they can be classified into 5 categories:

1The donation: This type of funding is mainly used by charities or NGOs and is based on a donation or patronage type system, without compensation. It can also be used to support a personal cause such as the payment of medical, schooling, funeral, or veterinary fees.

There are also donations with compensation, which in turn, aim at rather cultural and artistic projects (to edit a book or a comic strip, to produce a movie, a video game or a musical album, to organize a concert or a show, etc.).

Some companies sometimes call for donations, but they are either of social and solidarity vocation, or startups developing very innovative projects and likely to appeal to a wide audience.

Examples : justgiving.comgofundme.comdonorschoose.org

2Peer-to-peer lending (or crowdlending): It is similar to the bank loan, except that here, the Internet users are those who play the role of the bank. They choose to lend a portion of their savings for a fixed term and then recover that capital with interest. Interest rates are often higher than those charged by banks because the risk taken by investors is higher. This type of financing is mainly intended for businesses but also for individuals.

There are also so-called “solidarity” loans that work like micro-credits at zero rates. These are small loans between friends used to finance studies, obtaining a driving license, a move, holidays, etc…

In other cases, they are used to finance micro-entrepreneurs located in countries where access to credit is more difficult. No return on investment but there is the satisfaction of having given the chance to men and women around the world to develop their own livelihood activity or to have simply been able to help a loved one.

Examples : lendingclub.comkiva.orgzidisha.org

3Reward-based crowdfunding : This is the most well-known system because it is the one that is mostly used on most crowdfunding platforms. Here, the individual helps to finance a project without expecting any financial return but generally receives a reward that varies according to the amount given. This can be a simple thank you card, the product financed by the campaign, sometimes in a personalized version or accompanied by a bonus, a dinner with the project holders, etc… For the user, it is not an investment but rather a “big crush”.

Examples : KickstarterUluleIndiegogoKisskissbankbank

4Equity financing : In this case, the internet user is an investor who chooses a project based on the profit that he thinks he can draw, and if the project is a commercial success, he will be paid in the form of shares or royalties. It is, therefore, a financing method that is aimed exclusively at businesses which makes it possible to take a direct stake in their share capital.

Examples : angel.coseedinvest.com

5The electronic tip : This method appeared quite recently and was popularized by some famous bloggers and youtubers (and especially with the rising of online advertisement blockers), these platforms are based on the principle of the tip. Unlike other forms of crowdfunding, the Internet user can decide here to give a sum of money once or monthly to an artist, creator of content, or anyone else he wishes to support.

Examples : TipeeeBuy Me A CoffeePatreon

Gif: Ned Flanders giving a tip at a bar

Is it free?

Not really. You should know that all these platforms take a commission that is generally around 3% or 5%, but it can be much more. To this is added a percentage for payments by credit card like Visa, MasterCard, Amex, etc. It is, therefore, interesting to compare the different platforms before deciding.

I will not dwell on the tax side of crowdfunding because the variations can be significant from one country to another, but keep in mind that your government will probably claim its share of the cake.

If you’re interested in this way of raising funds, I’ve written an article where I give you 32 tips on how to succeed in your crowdfunding campaign. It will help you to put all the chances on your side, but be prepared to work hard for several weeks!

32 tips for a successful crowdfunding campaign
32 Tips for a Successful Crowdfunding Campaign

Here are 32 highly valuable tips that will help you set up your fundraising campaign, but more importantly, ensure its success on crowdfunding platforms. Here’s the program: Crowdfunding ? Comment mettre en place une campagne de crowdfunding ? Avant la...

Some Famous Crowdfunding Campaigns

Some crowdfunding campaigns have been more significant than others. Here is a small anthology:

The biggest amount on Kickstarter : There were some nice shots such as the Pebble Time project, a smartwatch that raised more than $20,338,986, but one of the most famous is that of Ryan Grepper and his idea of a multifunction cooler box and which holds the second record of the largest amount ever collected on Kickstarter. This cooler with wheels named simply “Coolest” is loaded with digital gadgets (Bluetooth, speakers, USB ports, etc.). The amount is 13,285,226 dollars! 62,642 people contributed to the financing of this project, which went into commercialization. In any case, it confirms this story about the attachment that Americans have for their coolers.

A cooler and watches, on Kickstarter Source Kickstarter

The most dazzling: In 2016, Mundo, a mobile bank available exclusively via an iPhone or Android application, raised more than one million pounds on the Crowdcube platform in just… 96 seconds! A total of 1,861 contributors participated in this campaign and gave £542 each on average.

One of the craziest : In 2012, a rather unusual petition circulated on American social networks. Clearly, it asked the US government to build the Death Star of the empire, a famous weapon of mass destruction well known to the aficionados of the Star Wars saga. The government estimated that the project could cost nearly 10 times the GDP of the entire Earth, so they wisely declined the proposal.

Never mind, a year later, an English guy launches a crowdfunding campaign to finance the construction of this dreadful weapon. He asked for about £20,000,000 to get the job started but estimates that the total cost should be around $850,000,000,000,000,000 (yeah, that’s a lot—a lot—of zeros).

Finally, and without much surprise, the goal will not be achieved. 2,400 contributors still supported the project up to £300,000 but, as it was clearly a joke, they thankfully were all paid off.

The Death Star The Death Star – Background by Oleg Gamulinskiy on Pixabay

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