What is Crowdfunding?
Crowdfunding refers to the method through which the business can raise capital from a large number of individuals beyond friends, family, relatives, and customers, by posting the project details on the websites and other social media platforms. It is basically the source of finance that does not involve banks and any other financial institutions.
How does it Work?
- The entrepreneur who wants to raise funds through crowdfunding and the small investors who are interested in funding new businesses and business ideas needs to register at the official crowdfunding websites. These websites are the medium between investors and entrepreneurs.
- The entrepreneur has to put the idea along with projections of the business through the crowdfunding website so that the potential investors could decide whether to invest or not to invest.
- Along with the idea and projections, the entrepreneur has to quote the minimum amount the investor can invest. The minimum amount can be as low as $10.
- The potential investor needs to show interest in investing along with the minimum amount it can invest and the procedure as well as details of the investments.
- If over applications are received, the excess money is to be repaid to the investors.
- Once the funds are raised and received, the entrepreneur has to pay fees to the crowdfunding websites. The fee is based on the percentage of fundraising.
- The percentage of profit generated from the business needs to be shared with the investors by way of return on investment.
Types of Crowdfunding
- Donation-Based Crowdfunding: Through this, funds for social projects are raised. It might be through awareness on social media platforms etc.
- Reward-Based Crowdfunding: In reward-based crowdfunding, the investors get rewards to correspond to the money invested by them. Mostly new startups prefer reward-based crowdfunding where the rewards given by them can be gifts, coupons, goods & services, etc.
- Equity Crowdfunding: The investors get equity against the investment in the company. Therefore, in this case, the investors become the owners of the company.
- Debt Crowdfunding: In this, the company promises to repay the amount invested along with interest.
- Real Estate Crowdfunding: In this, the company invests the fund raised in the real estate sector and promises to provide heavy returns once it started earning.
Examples of Crowdfunding
Animoodles is one of the companies which raised funds through the idea of crowdfunding. It started a business of manufacturing and supplying advanced toys that have the character of animals and famous cartoons along with the sound on them through the magnet on the back of toys. The company put the idea and collected the funds through the crowdfunding within 11 hours. They raised around $1.5 million in the campaign of raising $1 million.
All the entrepreneur can do is to present the idea so effectively that would attract many investors.
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- All the Transactions from the fund raised from crowdfunding needs to be registered with the security exchange commission unless it meets the exemption criteria defined by the commission.
- Projects are needed to be displayed at the website as well as they are to be registered with the security exchange commission and the business for which funds are to be raised needs to be legal.
- Transparent accounts and movement of fund statement is to be displayed at the website so that the investors can get the information about the application of their funds.
- Security Exchange Commission needs to put the yearly limit on the amount to be raised in aggregate as well as individual investor wise.
- All disclosures and information need to be filed with the security exchange commission.
- Attracting potential investors is a difficult task as the company needs to earn trust through convincing projects.
- More transparency and registration of transactions with the security exchange commission may lead to no secrecy as the business needs secrecy regarding some important matters.
- The targets and deadlines defined in the project need to be fulfilled on time and should be realistic in nature.
- Timely returns are the biggest challenge as because of low or no returns, the ratings, and the reputation of the organization are affected.
- These funds can be raised without any security.
- It is an easy and useful way of raising funds.
- Through this, the funds can be raised within a short period of time.
- It is an effective way of promoting an attractive business idea, along with talent.
- Through this, many small investors can be attracted as the minimum investment amount is low and affordable.
- The major risk involved in crowdfunding is the risk of fraud or loss of investment.
- The risk of a company might not fulfil the commitments at the time due to unfavourable business conditions or any other reasons.
- Risk of failure of the projected plan and dealing with it.
- Risk of payment of a return on investment on a timely basis.
This has been a guide to What is Crowdfunding & its Definition. Here we discuss its rules, types and how it works along with examples, challenges, risks, and advantages. You can learn more about from the following articles –