What is Crowdfunding?

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How does it Work?

  • The entrepreneur who wants to raise funds through crowdfunding and the small investors interested in funding new businesses and business ideas must register at the official crowdfunding websites. These websites are the medium between investors and entrepreneurs.The entrepreneur has to put the concept and projections of the business through the crowdfunding website so potential investors can decide whether to invest.Along with the idea and forecasts, 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, the minimum amount it can sponsor, and the procedure and details of the investments.If overapplications are received, they will repay the excess money to the investors.Once the funds are raised and received, the entrepreneur pays fees to the crowdfunding websites. The cost is based on the percentage of fundraising.The profit generated from the business needs to be shared with the investors by 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. Most new start-ups prefer reward-based crowdfunding, where their rewards 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 company’s owners.Debt Crowdfunding: In this, the company promises to repay the amount invested and interest.Real Estate Crowdfunding: The company supports the fund raised in the real estate sector and pledges to provide heavy returns once it starts 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 with the character of animals and famous cartoons and the sound on them through the magnet on the back of toys. The company put the idea and collected the funds through crowdfunding within 11 hours. They raised around $1.5 million in the campaign of raising $1 million.

The entrepreneur can present the idea so effectively that it would attract many investors.

Rules

  • All the transactions from the fund raised from crowdfunding need to be registered with the security exchange commission unless it meets the exemption criteria defined by the commission.Projects must be displayed on the website and 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 statements are to be displayed on the website so that the investors can get information about the application of their funds.The Security Exchange Commission needs to put a yearly limit on the amount raised in aggregate and by individual investors.One must file all disclosures and information with the security exchange commission.

Challenges

  • Attracting potential investors is difficult 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 important matters.The targets and deadlines defined in the project need to be fulfilled on time and realistic.Timely returns are the biggest challenge because of low or no returns, the ratings, and the organization’s reputation.

Advantages

  • One can raise these funds without any security.It is an easy and useful way of raising funds.Through this, one can raise funds within a short period.It is an effective way of promoting an attractive business idea and talent.It can attract many small investors as the minimum investment is low and affordable.

Risks

  • The major risk involved in crowdfunding is the risk of fraud or loss of investment.The company’s risk might not fulfill the commitments due to unfavorable business conditions or 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 article is a guide to Crowdfunding and its definition. Here, we discuss its types and works with crowdfunding examples, challenges, risks, and advantages. You can learn more about it from the following articles: –

  • Equity FinancingVenture Capital FinancingDebt Financing vs Equity FinancingMezzanine Financing