Crowdfunding: What it is, types, how it works, best practices and alternatives.

Have you ever had a brilliant idea for business for a business, but lacked the funds to start it? Or perhaps your existing business needs a cash injection to take it to the next level? This is a familiar struggle for many entrepreneurs in India, but there is now a solution: crowdfunding.

Crowdfunding involves raising small amounts of money from a large number of people via the internet. It is a relatively new concept in India but is growing rapidly in popularity.

What is crowdfunding?

Crowdfunding is a method of raising funds for projects, products, or causes by pooling small contributions from a large number of people, typically through online platforms. It allows entrepreneurs, artists, startups, and social causes to bypass traditional financing avenues like banks or venture capitalists. In return for their contributions, backers may receive rewards, equity, or pre-purchased products/services. Crowdfunding democratises funding, enabling individuals to support ideas they believe in and participate in their success.

How does it work?

Crowdfunding platforms allow businesses to create a campaign and pitch their idea to potential investors. The campaign typically includes a description of the business or project, the funding goal and the rewards or equity on offer for backers.

The benefits of crowdfunding are numerous. Firstly, it provides a way for entrepreneurs to access funding that they may not have been able to secure otherwise. Traditional loans can be difficult to obtain, particularly for startups or early-stage businesses with no proven track record. Crowdfunding allows businesses to tap into a wider pool of investors who are willing to take a chance on a promising idea.

Secondly, crowdfunding can also help businesses to validate their idea. If a campaign does not gain traction, it may indicate that there is not enough demand for the product or service. Alternatively, if a campaign exceeds its funding goal, it shows that there is a market for the idea and can attract the interest of larger investors.

Thirdly, crowdfunding is a powerful marketing tool. By creating a campaign, businesses can generate buzz and awareness for their brand. They can also build a community of loyal customers who are invested in the success of the business.

Types of crowdfunding

There are several types of crowdfunding available in India, including donation-based, reward-based and equity-based crowdfunding.

• Donation-based crowdfunding: Backers donate money to a cause or charity without expecting anything in return.
• Reward-based crowdfunding: Backers receive rewards, such as early access to a product or service, in exchange for their support.
• Equity-based crowdfunding: Investors receive equity in the business in exchange for their financial support.
• Peer-to-peer lending: Individuals lend money directly to other individuals or businesses through online platforms, with terms for repayment and interest rates agreed upon.
• Profit-sharing crowdfunding: Backers receive a share of the profits generated by the project or business in proportion to their investment.
• Hybrid models: Combination of different crowdfunding types, offering backers a mix of rewards, equity, or profit-sharing depending on their level of contribution. These models provide diverse options for both project creators and backers in India.

Before choosing a crowdfunding platform, businesses need to consider several factors, such as fees, payment processing, and platform reputation. It is also important to have a well-thought-out campaign, including a clear funding goal, an engaging pitch, and enticing rewards or equity.

Crowdfunding provides a new and exciting way for businesses in India to access funding and launch their ideas. It offers numerous benefits, including validation, marketing and community-building. So, if you have a dream business idea that needs funding, consider crowdfunding as your next step.

How to choose which type of crowdfunding to use

Choosing the right type of crowdfunding for your startup depends on your business nature, goals, and capacity to meet each method’s demands. Consider the following factors when deciding:

1. Nature of your business or project

• If you’re launching a product or service, reward-based crowdfunding may be ideal.
• For socially-driven ventures, donation-based crowdfunding is a good fit.
• If scaling a business with traction and willing to share equity, equity-based crowdfunding works best.
• If you prefer maintaining ownership and can repay loans, opt for debt-based crowdfunding.

2. Financial needs and objectives

• For larger capital, equity or debt-based crowdfunding is more suitable.
• For smaller funding needs, reward or donation-based crowdfunding might suffice.

3. Market validation

• Reward-based crowdfunding helps test your product in the market, providing valuable customer feedback.
• Ownership and control
• If maintaining ownership is critical, reward, donation-based, or debt-based crowdfunding is preferable to equity-based methods.

5. Ability to fulfil obligations

• Can you deliver rewards on time for reward-based crowdfunding?
• Are you confident about loan repayment for debt-based crowdfunding?
• Can you manage shareholders in equity-based crowdfunding?

6. Legal and regulatory considerations

• Equity and debt-based crowdfunding involve more complex legal requirements than reward or donation-based methods. Ensure you understand these obligations.

Crowdfunding for business: Best practices

Now that you understand crowdfunding and its various types, let’s explore how to effectively use it for your business. Here are a few best practices to keep in mind when raising capital through crowdfunding:

1. Choose the right crowdfunding platform: Not all crowdfunding sites are the same. Some are geared towards fundraising and are ideal for donations, while others are focused on launching new products or equity crowdfunding. Research the available platforms and select one that aligns with your business goals and funding needs.
2. Develop a clear strategy to attract investors: Crowdfunding has become highly competitive, with more businesses using these platforms to raise money. Before launching your campaign, define your strategy. Identify your target investors, outline how you will market your campaign, and highlight why your business is a worthy investment.
3. Maintain communication with your investors: In traditional investing, you may have one or two major investors. In crowdfunding, however, you may have hundreds or even thousands of backers contributing smaller sums. Despite this, they still expect regular updates on their investment. Keep your backers informed about your project’s progress, especially if you’re developing a new product, and share photos, videos, and delivery timelines.
4. Set realistic goals: Crowdfunding offers exciting possibilities, but it’s crucial not to overpromise. Clearly define the amount of funds you need and ensure you can deliver based on that. For instance, in a rewards-based campaign, set achievable targets and avoid taking on so many investors that fulfilling rewards becomes unmanageable. Similarly, with equity crowdfunding, avoid selling so much equity that it undermines your business model.

In summary, a well-executed crowdfunding campaign can help you meet your funding goals. However, overextending yourself could cause more harm than good, so set realistic objectives and create a strong strategy without going overboard.

Key to crowd funding success

1. Your business distinguishes itself: A successful crowdfunding campaign depends on your ability to attract the interest of potential donors or investors. This might involve having a unique product that addresses a market gap or a compelling personal or business story that persuades investors to support your venture.
2. Investors appreciate your rewards: Ensure you offer rewards that are appealing enough to attract interest. Rewards can include products or services, but also extend to personal coaching, classes, or exclusive invitations to company events.
3. You have a broad network: Having support from family, friends, and business contacts can significantly enhance your fundraising efforts. Without a strong promotional base, reaching your financing goals becomes more challenging.

Advantages and disadvantages of crowdfunding

Advantages of crowdfunding

1. Broader Investor Reach: Crowdfunding provides access to a wide and diverse group of investors or supporters. Social media platforms enhance this reach, helping businesses and individuals grow their audience and secure necessary funding.
2. Equity Flexibility: Equity-based crowdfunding is increasingly popular as it allows startups to raise capital without surrendering control to venture capitalists. It can also offer investors the chance to acquire an equity stake in the business. In the US, the Securities and Exchange Commission (SEC) regulates equity-based crowdfunding.

Disadvantages of crowdfunding

1. Reputation Risk: There is a potential risk of damaging your or your company’s reputation if the crowdfunding campaign is not successful or managed poorly.
2. Fees: Crowdfunding platforms often charge fees, which can reduce the overall amount of funds raised.
3. Funding Goal Shortfall: If the campaign fails to meet its funding goal, pledged funds are returned to investors, leaving you without financial support.

Examples of crowdfunding

In India, crowdfunding has facilitated the realisation of diverse projects, offering backers the chance to contribute as little as Rs. 100 to projects they believe in. For instance, campaigns have raised substantial amounts for various causes, from supporting local artisans to funding innovative startups. These examples highlight how crowdfunding has empowered Indians to support causes and projects they are passionate about, showcasing the impact of collective contributions in driving positive change.

What are the alternatives to crowdfunding?

Startups have several crowdfunding options, which can be divided into two main categories: debt financing and equity financing.

1. Debt financing

• Bank loans: Traditional bank loans are a popular method for financing a startup. They typically require a robust business plan and collateral.
• Lines of credit: Banks or credit unions offer lines of credit, providing businesses with flexible access to funds.
• Microloans: Non-profit organisations and online lenders offer smaller loans that are often easier to obtain than traditional bank loans, especially for businesses with limited credit history.

2. Equity financing

• Angel investors: Angel investors are affluent individuals who invest their personal funds in startups in exchange for an equity stake. They may also offer expertise and valuable industry connections.
• Venture capitalists (VCs): VCs are firms that invest in startups and early-stage companies with high growth potential. They generally require an equity stake and may seek some control over the company.
• Private equity firms: These firms invest in more mature companies with the goal of enhancing their value before selling them at a profit. They usually demand a significant stake or outright ownership.