Crowdfunding: What It Is, How It Works, Types & Websites

By Martin Christensen
October 4th, 2023
17 minutes read
Image of a crowd funding an idea

What is Crowdfunding?

Crowdfunding is a digital fundraising strategy, enabling individuals or businesses to raise money from people via online platforms, to support businesses, projects, or causes.

It is a way for startups and growing businesses to get the money they need without going to a bank. It's all about using the internet to talk about your company or ideas and get people excited enough to give you money to make them happen.

Funding your idea through the crowd isn't only a financial journey but also a community-building adventure. It's a unique blend of gathering funds while simultaneously creating a network of supporters and ambassadors around your idea. This approach not only helps you financially but also provides a platform to gain insightful feedback and forge connections with new customers, all under the umbrella of nurturing your project with the funds it needs.

Key Takeaways

  • Crowdfunding allows contributors and investors to select from thousands of campaigns and invest or donate as little as $1.
  • Crowdfunding sites generate revenue from a percentage of funds raised or directly from charging investors on funds provided.
  • The SEC regulates equity crowdfunding campaigns in the United States (RegCF). In the EU both equity and debt crowdfunding for businesses is regulated by the individual country’s financial regulator following overarching EU regulations (ECSPR).
  • GoFundMe, Kickstarter, Indiegogo, Patreon and StartEngine are the most popular crowdfunding platforms in the world.

How Crowdfunding Works

Crowdfunding unfolds a dynamic interaction between dreamers and believers on digital crowdfunding platforms. Crowdfunding platforms serve as vibrant marketplaces where innovators and supporters meet to bring ideas to life through collective financial backing.

These platforms are not just transactional hubs but are existing to offer a secure, user-friendly experience, safeguarding both the dreamer's vision and the supporter’s contribution. A typical model in crowdfunding is the all-or-nothing approach. Reach your financial target and the funds are yours and if you don’t, everyone’s contributions are returned.

Imagine you want to create a unique type of shoe, but you need money to make it. You share your shoe idea on a crowdfunding platform, explaining why it's special and how you'll create it. People who love your idea can give you money to help you reach your needed amount. In return, they might get a pair of shoes, a thank-you note, or even a small share of your company, depending on the type of crowdfunding you choose. It’s a way of making exciting ideas happen by pooling money together online.

The most popular crowdfunding campaign in the world was from the author Brandon Sanderson who wanted to publish a series of novels during 2023. His fundraising goal was $1,000,000, but he raised more than $41,000,000 from 185,341 backers in a rewards-based crowdfunding campaign.[1]

Contributors in crowdfunding can select from thousands of projects starting from as little as $1. The crowdfunding sites make money from a percentage of the funds raised or by directly charging the backers and investors. While donation and reward projects are typical, the most used types of crowdfunding today are for profit-making SMEs and startups.

Types of Crowdfunding

The most common uses of crowdfunding are startups looking to bring a product or service into the world, individuals experiencing a type of emergency or SME businesses looking to borrow money for operations or real estate. The majority of crowdfunding platforms focus on crowdfunding investment campaigns, utilizing debt-based crowdfunding or equity-based crowdfunding.

However, despite the for-profit crowdfunding industry being the largest in number of platforms, the largest and most recognized crowdfunding platforms focus on non-profit projects by hosting rewards-based crowdfunding and donation-based crowdfunding campaigns.

Illustration of the 4 types of crowdfunding models
  • Debt-based crowdfunding, also known as peer-to-peer lending, involves investors lending money with the expectation that it will be repaid with added interest, according to agreed-upon loan terms.
  • Equity-based crowdfunding allows investors to buy shares in a company or project, becoming partial owners with a stake in its potential success.
  • Reward-based crowdfunding lets backers give money in return for a non-financial reward, often a product or service that's in development.
  • Donation-based crowdfunding entails donors giving money to support a cause or project without expecting any financial or tangible return.

The most popular crowdfunding websites GoFundMe, Kickstarter, Patreon, Indiegogo and StartEngine attract millions of people eager to develop, or back, the latest social emergencies, upcoming business or noble causes. Together, they have amassed over $25 billion for social initiatives, events, artists, innovative products, and entrepreneurial ideas.

GoFundMe

GoFundMe is the largest crowdfunding platform in the world with more than $10 billion raised from more than 120 million donations since it launched in 2010.[2] GoFundMe is widely recognized as the go-to platform for individuals navigating through financial challenges due to medical issues, house fires, natural disasters, or unforeseen emergency costs, while Kickstarter is commonly utilized by start-up companies. GoFundMe is the most popular donation-based crowdfunding platform in the world.

Kickstarter

Kickstarter, established in 2009, ranks as the second most favored crowdfunding platform, boasting over 5 million supporters and surpassing $7.5 billion in pledges towards 250,000 successful campaigns.[3]

Known as the best site for innovative business concepts and fresh products, it distinguishes itself from GoFundMe by exclusively hosting projects that offer shareable rewards. Kickstarter is the most popular rewards-based crowdfunding platform in the world and maintains strict guidelines on the types of projects and rewards it allows. It prohibits the use of the platform to raise funds for charity or causes and disallowing incentives like equity or investment opportunities. Projects cannot involve items that claim to diagnose or treat illnesses, engage in political fundraising, or involve drugs, alcohol, contests, or gambling.[4]

Patreon

Patreon has distinguished itself from other major crowdfunding platforms by focusing on content creators, assisting over 250,000 creators in securing more than $3.5 billion in payouts from fans.[5] The platform enjoys particular popularity among artists, musicians, YouTubers, and podcasters who consistently produce content.

Since its inception in 2013, the platform has enabled creators to receive recurring financial support directly from their fans in exchange for exclusive content, perks, or experiences. This allows fans to receive direct access to art, writings, videos, podcasts and other creative projects.

Indiegogo

Indiegogo is like Kickstarter, a popular rewards-based crowdfunding platform dedicated to breathing life into new products and business ideas by connecting them with the necessary financing. The Indiegogo community, comprising over 9 million backers, has successfully funded $2 billion in over 800,000 innovative ideas across 235 countries and territories.[6]

The platform notably allows campaigners the choice between fixed or flexible funding models, allowing the funds to be paid out before reaching its funding goal compared to its competitor Kickstarter. Indiegogo stands out as a popular choice for crowdfunding, especially outside of the United States, with a pronounced focus on the Chinese market where it has helped more than 150 companies raise funds.[7] In 2021 the platform further stamped its presence in the market for entrepreneurs by partnering with the equity crowdfunding platform StartEngine.[8]

StartEngine

StartEngine has established itself as the leading platform for startup equity crowdfunding globally, facilitating over $1 billion in funding for innovative startups since launching in 2014.[9] With a robust network of more than 1.7 million prospective investors, the platform serves as a dynamic hub where individuals are ready to invest in the next groundbreaking idea in exchange for company equity.

The platform allows startups to raise up to $5 million each year in RegCF and up to $75 million in Reg A+ offerings. Serving as a pivotal crowdfunding hub for entrepreneurs, StartEngine boasts the endorsement of none other than "Mr. Wonderful" – Kevin O’Leary from the TV show Shark Tank, who is a paid spokesperson for StartEngine.[10]

Pros & Cons of Crowdfunding

Crowdfunding has emerged as a vibrant and accessible method for individuals and startups to bring their innovative ideas to life. By tapping into a global network of investors and supporters through online platforms, it democratizes the funding process in a way traditional methods simply can't.

Pros of Crowdfunding

  • Diverse Funding Pool: Crowdfunding opens the door to a wide array of investors and supporters, amplifying the reach and potential of your project through social media and online networks.
  • Rewards and Engagement: Often, crowdfunding operates on a rewards-based system, offering backers exclusive perks such as early access to products, special editions, or even a simple thank-you note, fostering a community of engaged supporters.
  • Equity without Losing Control: Particularly with equity-based crowdfunding, entrepreneurs can raise capital without relinquishing too much control to venture capitalists, and investors get a slice of the pie in return. In the United States, the Securities and Exchange Commission (SEC) regulates equity crowdfunding campaigns.[11] In the European Union, the European Crowdfunding Service Provider for Business Regulation (ECSPR) governs both debt and equity-based crowdfunding.[12]
  • Market Validation: It provides a platform to validate the product or idea in the market. If your project gets funded, it’s a good indicator that there is a demand.

Cons of Crowdfunding

  • Reputation Risks: Leveraging crowdfunding can sometimes be perceived as a desperate measure, potentially risking the reputation of your startup by publicly acknowledging a lack of funds.
  • Platform Limitations: Adhering to the rules and fees of the crowdfunding platform can sometimes be restrictive, and failing to meet your financial target might mean you walk away with nothing. Crowdfunding platforms typically charge up to 10% on funds raised.[13]
  • Pressure and Accountability: With numerous backers to answer to, the pressure to deliver on promises becomes paramount, and any failure or delay can result in public backlash.
  • Intellectual Property Concerns: Exposing your idea or product to a wide audience can risk imitation or theft of your concept, especially if proper IP protections aren’t in place.

In a nutshell, while crowdfunding offers a unique and inclusive way to fund your project, it comes with its own set of challenges and risks. Balancing the potential gains against the possible pitfalls is crucial to navigate through the crowdfunding journey successfully.

Examples of Crowdfunding

Many crowdfunded ideas and businesses have blossomed into highly successful and profitable ventures. For instance, the Pebble Smartwatch, initially launched on Kickstarter, managed to raise over $20 million from more than 70,000 backers, becoming one of the most successful crowdfunding campaigns ever and sparking a revolution in the wearable tech industry.[14]

The list of crowdfunded unicorns continues to expand as various businesses evolve into unicorn companies through the strategic use of crowdfunding. Brewdog via Crowdcube, LuggageHero through Seedrs, Revolut on Seedrs and Oculus VR on Kickstarter are renowned companies, now valued at over $1 billion, that initiated their paths with the aid of crowdfunding.

Do you pay back crowdfunding?

Whether you pay back crowdfunding depends on the type of crowdfunding model you use. Donation-based doesn't require payback, rewards-based offers products or perks instead of money, equity-based provides company shares with no direct repayment, while debt-based (peer-to-peer lending) mandates repaying backers with interest.

How do crowdfunding investors get paid?

In crowdfunding, how investors get paid varies by type. With equity crowdfunding, investors may gain financial returns through dividends or profit if the business thrives. In debt crowdfunding, investors are repaid with interest over a specified period. Rewards-based crowdfunding provides investors with non-monetary rewards, such as the product being funded, while donation-based crowdfunding typically offers no financial return, as funds are given philanthropically.

Has anyone made money from crowdfunding?

Yes, numerous people have made money from crowdfunding. In equity crowdfunding, investors can earn money if the business they've invested in becomes profitable, while in debt crowdfunding, investors earn back their investment with interest over time. There are various success stories where businesses funded through crowdfunding platforms went on to become highly successful, providing returns to their early backers. In real estate crowdfunding thousands of investors are earning a return every month from interest payments on real estate loans. However, it's crucial to note that investing through crowdfunding can be risky, and not all campaigns lead to profitable outcomes.

Is crowdfunding safe?

Crowdfunding, a potent tool for raising funds, navigates a delicate balance between being safe and risky. On one hand, numerous platforms operate under regulatory frameworks, providing a sense of safety and structure for both project creators and backers. On the other hand, the absence of universal regulation across all platforms can expose participants to unsuccessful projects or even frauds. 

While stories of triumphant crowdfunding campaigns that propelled innovative projects to success abound, tales of unfulfilled promises and mismanaged funds also echo in the crowdfunding sphere. Thus, the safety in crowdfunding often hinges on diligent research, prudent decision-making, and navigating through platforms that adhere to regulatory standards, ensuring a secure environment for investment and fundraising.

Yes, crowdfunding is legal in India, but it is subject to certain regulations and restrictions. The Securities and Exchange Board of India (SEBI), which regulates the securities market in India, has issued guidelines related to crowdfunding, particularly for equity-based crowdfunding.[15]

Is crowdfunding FCA regulated?

Yes loan-based crowdfunding, or peer-to-peer lending, and investment-based crowdfunding, involving purchasing shares or debentures, are regulated under the Financial Services and Markets Act 2000. Additionally, the FCA regulates payment services related to donation-based crowdfunding, where money is given to support enterprises, and rewards-based crowdfunding, where contributions are made in exchange for a reward, service, or product. Engaging with FCA-compliant platforms ensures adherence to established regulations, safeguarding consumer interests.[16]

Article Sources

  1. Kickstarter: “Four Secret Novels by Brandon Sanderson”
  2. GoFundMe: “About Us”
  3. Kickstarter: “Kickstarter Stats”
  4. Kickstarter: “Prohibited Items”
  5. Patreon: “About Us”
  6. Indiegogo: “Our Story”
  7. Indiegogo: “Indiegogo China: Your Fast Track to the Global Market”
  8. Indiegogo: “Indiegogo and Equity Crowdfunding: A Beautiful Parigin for Entrepreneurs”
  9. StartEngine: “Raise Capital”
  10. StartEngine: “About Us”
  11. Securities and Exchange Commission (SEC): “Regulation Crowdfunding”
  12. EUR-lex: “Regulation European Crowdfunding Service Providers for Business”
  13. Fundly: “Crowdfunding Fees: The True Cost of 7 Popular Platforms”
  14. Kickstarter: “Pebble Time - Awesome Smartwatch, No Compromises”
  15. Securities and Exchange Board of India (SEBI): “Consultation Paper on Crowdfunding in India”
  16. Financial Conduct Authority (FCA): “Crowdfunding Regulation”