February 8, 2024

How crowdfunding actually works in 2024, and whether you should use it to raise money

Reading Time: 7 minutes

Crowdfunding is to financing what Uber is to taxis or what Airbnb is to hotels: Using the wisdom and resources of the crowd to raise money.

Usually, crowdfunding brings many smaller investors or donors together to fund a business, startup or personal initiative. The concept is based on the collective effort of a large number of individuals investing small amounts and leveraging the internet as a platform to present their campaigns and reach potential investors worldwide.

To put it in simple terms, crowdfunding is the modern-day equivalent of tossing coins in a hat to help create funds for a cause or idea. Essentially, it is when an individual, startup or organization pitches their idea to a large pool of potential investors with the hopes of raising a specific amount of money.

Types of crowdfunding

Broadly, there are four types of crowdfunding:

1. Reward-based crowdfunding: Backers give money to a project and receive a tangible item or service in return. Kickstarter and Indiegogo are popular platforms for this type.
2. Equity crowdfunding: Investors receive a stake in the company, typically in the form of equity shares. This type of crowdfunding is regulated by financial authorities to protect investors. This has been possible in Europe for a while, with Crowdcube and Seedrs leading the way. In the U.S., equity crowdfunding is more recent, with a number of sites popping up, including WeFunder, Start Engine and Republic.
3. Debt crowdfunding (or peer-to-peer lending): Backers lend money to the project or business with the understanding that the money will be repaid with interest. Platforms like Lending Club and Prosper facilitate this type of crowdfunding.
4. Donation-based crowdfunding: People donate to causes, projects, or organizations without expecting anything in return. GoFundMe is probably the best-known platform here.

How does it work?

Rather than raising large chunks of funding from institutional investors such as banks, venture capitalists or private equity firms, crowdfunding solicits a mass number of smaller investments from the public.

These potential investors are presented with a well-crafted campaign detailing everything from the concept and roadmap to potential benefits for supporters. Depending on the type of crowdfunding, a campaign could offer rewards to backers, equity in the business, or simply the satisfaction of contributing to a worthy cause.

Pros and cons of crowdfunding for startups

Crowdfunding offers a novel way for startups to raise funds, validate their market, and build a community. However, it also requires substantial effort and can defocus activity away from building the startup for significant stretches of time.

Crowdfunding pros

Crowdfunding provides a way to raise funds without traditional bank loans or giving up equity to venture capitalists. It’s particularly useful for startups that may not have access to traditional funding sources.

This can also help find market validation: By ‘selling’ the product before it is mass manufactured, you get early feedback and gauge market interest. A successful campaign can be a strong signal that there’s demand for your product or service.

The cool thing is that a crowdfunding campaign can double as a marketing campaign. It creates buzz and provides a platform to share your story, mission, and vision, potentially attracting customers, investors, and media attention.

Crowdfunding also often attracts early adopters who get very excited about the product existing; it can be a great way to find a community of supporters who are invested in your success. These early adopters can provide valuable feedback, promote your brand and remain loyal customers for many years to come.

Another benefit is that crowdfunding is a relatively low financial risk to the startup. Unlike traditional loans, crowdfunding doesn’t require repayment if the business doesn’t succeed.

Crowdfunding cons

It’s not all rainbows and unicorns, however. Crowdfunding campaigns carry risks and downsides, too. Creating and managing a successful crowdfunding campaign requires significant effort, including creating promotional materials, updating backers, and handling logistics. Good campaigns need to be well-marketed, which can get really expensive, too.

Another challenge is that by sharing your idea with the public, you risk exposing it to potential competitors. You’re also effectively prototyping in public, so there’s a possibility of receiving negative feedback or criticism — even if the criticism isn’t valid (after all, people haven’t tried your product yet), it’s out there in black and white, which brings some reputational risk.

While there’s usually limited financial risk, successful crowdfunding campaigns do have obligations. The idea is that you have to deliver on promises made to backers, which can include production and delivery of products. This can be challenging for a new startup.

Most platforms also have a curious quirk: You have to meet your fundraising goal to receive any money. Failing to meet your goal can mean getting nothing, even if you raise a significant amount.

Apropos raising significant amounts — crowdfunding platforms typically charge a percentage-based fee on the funds raised, which can impact the total amount you receive.

Of course, if the platform itself adds value, that might be worth it, but for many startups, the fees can prove to be significantly higher than they’d have been if you’d have made more traditional sales.

6 tips for running a successful crowdfunding campaign

1. Don’t have a crummy product

The market today is inundated with new ideas and innovations, making it increasingly difficult for any product to stand out without a unique value proposition. A well-conceived product addresses a clear market need or solves a specific problem in a way that’s both effective and superior to existing solutions.

This superiority can be in the form of innovation, ease of use, cost-effectiveness, or a combination of these. This extends beyond its immediate market appeal.

In the context of crowdfunding, where you’re appealing directly to potential customers and investors, the product is your strongest pitch. Crowdfunding platforms are replete with discerning backers who are looking for not only innovative products, but also for evidence of viability, scalability and long-term value.

2. Don’t screw up the economics

The road to crowdfunding failure is paved with budgets not based in reality. Running a campaign comes with its own unique set of financial challenges, particularly in the realms of production and fulfillment.

Be acutely aware of the costs involved in bringing your product from concept to customer, and make sure you don’t miss out on any of the steps along the way: Unexpected expenses in product development, certification, testing, manufacturing, and logistics like shipping and returns have been the downfall of many a campaign.

Crucially, you need to price your products in a way that covers costs and generates profit, while still remaining attractive to backers. This delicate balancing act requires a thorough understanding of the economics of production and distribution, ensuring that the project remains financially viable throughout its life cycle.

Oh, and don’t assume that things go to plan. They absolutely, 100% guaranteed, will not.

3. Tell a great story

The power of great storytelling cannot be overstated. Great storytelling — such as this one from Tilt Five, which is a rallying cry to bring back tabletop gaming in an AR world — can lift products from ‘meh’ to ‘great’:

For crowdfunding in particular, where you’re selling the future, compelling narratives are as important as the innovative products or ideas. A great story captivates potential backers, creates an emotional connection, and brings them into the journey of the product or idea being funded.

Startups should see their crowdfunding campaign as an opportunity to start building their brand’s story, one that will evolve but always remain true to its core narrative and values. In essence, storytelling in crowdfunding is not just a means to an end; it’s an integral part of building a brand identity that resonates with customers, creates emotional investment, and stands the test of time in a rapidly evolving startup landscape.

4. Manage expectations

We’d argue that managing expectations is as critical as the campaign itself. Crowdfunding history is riddled with stories of campaigns that either failed to meet their goals, which is arguably ‘success’ — if you prove there’s no market for your product, you don’t have to go through the seven circles of hell that is manufacturing a product.

Far worse are campaigns that succeeded in funding but faltered in execution. The truth is, crowdfunding is a complex dance of product, marketing, customer service and a little bit of luck. As a startup founder, you have to understand that while optimism is a driving force, realism is their guiding star. Setting realistic goals and transparently communicating potential risks and challenges not only builds trust with backers but also cushions the impact if things don’t go as planned. This transparency is vital in managing the expectations of backers who are, in essence, early adopters and investors in your vision. How you deal with challenges now will show up as brand reputation further down the line.

5. Get some help

Rome wasn’t built in a day, but more importantly, it wasn’t built by a single person. Bringing a product to market is a multidisciplinary challenge, and it’s rare that a small startup team has all the skills to pull it all off. The good news is that you don’t have to.

Lean on the right people. Marketing specialists are crucial in crafting and disseminating your story to the right audience, creating pre-launch buzz, and leveraging the right channels for maximum impact. Similarly, product development experts bring insights into design efficiency, user experience, and cost-effectiveness, helping to refine your product to meet and exceed market expectations. These professionals enhance the quality and appeal of your campaign and prevent costly revisions and missteps.

The complexities of manufacturing and supply chains, especially overseas, require specialized knowledge. Experts in these fields can navigate the intricacies of cultural differences, language barriers, and business practices, ensuring quality production, along with legal, financial, and regulatory compliance. Logistics professionals are essential for efficient distribution, managing inventory, and handling customs, especially for international shipping. Their guidance ensures that your product reaches your backers and does so in a timely and cost-effective manner. In essence, surrounding yourself with the right team of experts is not just beneficial for a crowdfunding campaign — it’s a strategic necessity for success.

6. Share the love

There’s something community-forward about crowdfunding. Scrappiness and camaraderie still flow in the veins of the genre in a universe where cynicism otherwise runs pretty deep. If you’ve done a successful campaign, help your fellow crowdfunding humans by offering your shoulders to stand on. Share your experience, your highlights, and your lowlights. One example: Here’s my own story of how my $500,000 Kickstarter campaign failed in a giant nuclear cloud of naiveté, trusting the wrong suppliers, and bad luck.

Reference: https://techcrunch.com/2024/02/06/how-crowdfunding-works/

Ref: techcrunch

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