Crowdfunding combines the concepts of crowdsourcing and microfinancing, bringing together various individuals who commit small amounts of money to projects and entities they want to support. This is often done through websites that make it easy for entities to find potential funders. Funders could expect something in return for their contributions—such as equity, products, or services—or they may donate the funds.
Keep reading to learn more about the different types of crowdfunding you may encounter.
What Is Crowdfunding?
Crowdfunding is any financing method that involves taking small amounts of money from a large number of individuals. The people who fund these projects and entities may do so without expecting anything in return—they're donations to a cause they support. Others fund these projects in exchange for products, services, or equity in the entity.
This web-based funding method has transformed the ways businesses raise capital. One survey found that U.S. businesses raised a total of $1.04 billion through crowdfunding in 2018.
How Does Crowdfunding Work?
Many sites host some sort of crowdfunding effort, but they all function a little differently. They can broadly be broken down into the following categories.
Perhaps the most popular crowdfunding method comes in the form of rewards-based sites like Kickstarter and Indiegogo. With reward-based crowdfunding, people can pledge money to creative projects, a novel piece of technology, or any other product or service.
For example, a musician you like may use crowdfunding to produce their next album. They make a Kickstarter page for the new album, outlining the basic ideas they have for it. You (along with other fans) contribute $10 to the project. In return, you will receive a digital copy of the album when you're done.
These crowdfunding efforts often involve tiered rewards. To return to the music example, a $10 donation may earn you a digital copy of the album, but a $20 donation may earn you a vinyl album.
Ever loan small amounts of money to a friend or relative? Platforms like Lending Club and Prosper apply that same concept to crowdfunding. This enables borrowers to get access to funds outside of traditional banking channels. People willing to take a little risk to lend money to other individuals can create whole loan portfolios at the click of a button.
Crowdfunding sites are also used by nonprofits seeking donations. Sites like GoFundMe give organizations a free platform to raise funds for their causes. Instead of taking a cut of their donations, GoFundMe asks contributors directly for a donation to help keep the site running.
Contributors who give through sites like GoFundMe don't usually expect anything in return. They're simply contributing to a cause or organization that they support.
The smallest slice of the crowdfunding pie, equity crowdfunding nonetheless has the potential to change the way individuals invest their money. Equity crowdfunding enables investors to make real investments in private companies. Sites like AngelList, CircleUp, and OurCrowd offer their own take on equity crowdfunding.
Equity crowdfunding is less regulated than other methods of equity financing. While most businesses need to go through an SEC registration process to issue equity shares, companies can issue up to $1.07 million in securities through crowdfunding methods without going through that process.
There are limits on how much investors can invest through equity crowdfunding. These limits depend on the investor's income bracket and net worth. If either your net worth or annual income falls below $107,000, you can invest up to $2,200 or 5% of your annual income (whichever is greater) through equity crowdfunding every year.
Real Estate Crowdfunding
Real estate crowdfunding sites combine the concepts of crowdfunding and real estate investment trusts. Examples of these sites include Fundrise, RealtyMogul, and CrowdStreet. Contributors kick in small amounts in exchange for equity in real estate (often commercial real estate).
- Crowdfunding occurs when an entity seeks small-dollar funding from a large group of individuals.
- Crowdfunding is typically facilitated by websites that connect fundraising entities with individuals who are willing to contribute to that entity.
- The funders may or may not expect something in return for their funding. It could be viewed as a donation, or they may expect equity, products, or services.