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, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives and venture capitalists.

Key Takeaways

  • Restrictions apply to who is allowed to fund a new business and how much they are allowed to contribute.
  • Crowdfunding allows investors to select from hundreds of projects and invest as little as $10.
  • Crowdfunding sites generate revenue from a percentage of the funds raised.
  • The SEC regulates equity-based crowdfunding ventures in the United States.

Basics of Crowdfunding

In most jurisdictions, restrictions apply to who can 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 than $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 2019, crowdfunding is mostly synonymous with Kickstarter, as it is the largest crowdfunding platform. Since Kickstarter's founding in 2009, the site has funded more than 160,000 projects, with more than $4.2 billion 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 they want fixed or flexible models—this is probably the most significant difference between the two crowdfunding platforms. Kickstarter releases funds only after the campaign has reached its funding goal, whereas Indiegogo allows the campaigner to receive funding pro rata, or wait until their target is hit.

As a campaigner, it might be easier and less risky to go with flexible funding (i.e., receiving funds as they come); however, regardless of the amount 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.

How Investors Benefit from Crowdfunding

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 may send a free bar to each of its investors. Video games are a popular crowdfunding investment for gamers, who often receive advance copies of the game as a reward.

Equity-based crowdfunding is growing in popularity because it allows startup companies to raise money without giving up control to venture capital investors. It also offers investors the opportunity to earn an equity position in the venture. In the United States, the Securities and Exchange Commission (SEC) regulates equity-based crowdfunding.

Real World 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, Inc. (FB) 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 manufacture 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, is now available at Staples, Amazon.com, Inc. (AMZN), Brookstone and elsewhere. The company has sales ranging between $10 and $15 million.

In April 2019, Critical Role, a weekly live-streamed tabletop roleplaying game featuring a group of prominent voice actors, raised $4.7 million in just 24 hours for its latest animated special “The Legend of Vox Machina.” No other 2019 Kickstarter campaign has raised that amount over their entire 30 to 60 day raising period.