What is 'Crowdfunding'

Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together. Crowdfunding has the potential to increase entrepreneurship by expanding the pool of investors from whom funds can be raised beyond the traditional circle of owners, relatives and venture capitalists.

BREAKING DOWN 'Crowdfunding'

In the United States, crowdfunding is restricted by regulations on who is allowed to fund a new business and how much they are allowed to contribute. Similar to the restrictions on hedge fund investing, these regulations are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. Because so many new businesses fail, their investors face a high risk of losing their principal.

How Crowdfunding Works

Crowdfunding has created the opportunity for entrepreneurs to raise hundreds of thousands or millions of dollars from anyone with money to invest. Crowdfunding websites such as Kickstarter and Indiegogo attract thousands of people hoping to invest in the next big thing. In 2015, nearly 80,000 people put up more than $20 million on Kickstarter for a company that developed a smartwatch alternative to the Apple Watch.

Crowdfunding provides a forum to anyone with an idea to pitch it in front of waiting investors. One of the more amusing projects to receive funding was from an individual who wanted to create a new potato salad recipe. His fundraising goal was $10, but he raised more $55,000 from 6,911 backers. Investors can select from a hundreds of projects and invest as little as $10. Crowdfunding sites generate revenue from a percentage of the funds raised.

What's in It for Investors?

Many crowdfunding projects are rewards-based; investors may get to participate in the launch of a new product or receive a gift for their investment. For instance, the maker of a new soap made out of bacon fat sent a free bar to each of its investors. New video games are a popular crowdfunding investment for gamers, who are rewarded with advance copies of the game.

Equity-based crowdfunding is growing in popularity because it allows startup companies to raise money without giving up control to venture capital investors, and it offers investors the opportunity to earn an equity position in the venture. Investments in equity-based crowdfunding ventures are regulated by the Securities and Exchange Commission (SEC).

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