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, and 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 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 hundreds of projects and invest as little as $10. Crowdfunding sites generate revenue from a percentage of the funds raised.

Popular Crowdfunding Websites: Kickstarter & Indiegogo

Crowdfunding websites such as Kickstarter and Indiegogo attract hundreds of thousands of people hoping to invest in the next big thing. As of 2018, crowdfunding is mostly synonymous with Kickstarter, as it is the biggest crowdfunding platform there is: since Kickstarter's founding in 2009, more than 130,000 projects have been successfully funded on the crowdfunding site, with more than $3.5 billion dollars pledged across all Kickstarter projects. Indiegogo started as a crowdfunding site initially focused exclusively on raising money for independent films, but began accepting projects from any category a year after its launch in 2007.

Indiegogo is seen as a less strict and more flexible platform than Kickstarter, as it gives backers control over whether want fixed or flexible models--this is probably the biggest difference between the two crowdfunding platforms. Kickstarter releases funds only after the campaign has reached its funding goal, whereas Indiegogo provides the campaigner the opportunity between receiving funding as it comes or choosing to wait until he or she hits his or her target. 

As a campaigner, it is might be easier and less risky to go with a flexible funding (i.e., receiving funds as they come); however, regardless of how much money is raised, campaigners must still deliver on any promises made. For a backer, fixed funding is more attractive as it is associated with much less of a risk. 

Examples of Successful Crowdfunding Ventures 

Many of the products and businesses crowdfunded on Kickstarter became very successful and lucrative endeavors. For instance, Oculus VR, the American company specializing in virtual reality hardware and software products, was funded through the site. In 2012, founder Palmer Luckey launched a Kickstarter campaign to raise money to make virtual reality headsets designed for video gaming available to developers. The campaign crowdfunded $2.4 million, ten times the original goal of $250,000. In March 2014, Facebook acquired Oculus VR for $2.3 billion in cash and stock. 

Another example of a company that rose to success through the help of Kickstarter campaigns is M3D, a company founded by two friends that manufactures small 3D printers. David Jones and Michael Armani raised $3.4 million for their Micro 3D printer on the crowdfunding site in 2014. The tiny 3D printer, which comes with a variety of durable 3D inks to go along with it, is now available at Staples, Amazon, Brookstone and elsewhere, and the company has sales ranging between $10 and $15 million. 

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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