Crowdfunding is essentially a way for people, charities and businesses to raise money from people. It combines crowdsourcing and microfinancing and work by bringing together different people who commit money to projects or businesses they want to support.
It is a new yet quickly growing market and is completely changing the way people behave with their money. It is transforming the way companies raise capital.
What is Crowdfunding?
When a company decides to raise capital through crowdfunding, it can pitch by posting the project details on a crowdfunding website. This eliminates the need to visit a bank. The crowd is the organizations or people giving money.
What are the Types of Crowdfunding?
1. Investment-Based Crowdfunding. It is where you invest in a business and get stakes in return (shares). Firms like OurCrowd and CircleUp are online venture capitalists who provide access to invest in start-ups with $100.
2. Loan-Based Crowdfunding. You get a specified interest rate for lending money to the company. It is also known by the name peer-to-peer business lending. Lending Club is a peer-to-peer lending site that lends billions of dollars every year.
3. Donation-Based Crowdfunding. Money is donated to an individual or charity and you may receive a reward. Kiwa.org and other sites fund small businesses in emerging markets.
4. Reward-Based Crowdfunding. You support a project by giving money in return for some reward. Kickstarter and Indiegogo are examples of reward-based crowdfunding.
How Does Crowdfunding Work?
When visiting a crowdfunding website, you see the overview of projects being pitched. If you find a project you are interested in, you can look for additional details like how much the project wants to raise, how much has been raised so far, what the fund will be used for, how many people have invested so far and what reward you will receive.
The investment goes ahead only if the project is able to raise the full amount. You get a cooling off period of 14 days in case you change your mind.
Individuals use personal crowdfunding to raise money to support themselves or their friends and family members using sites like YouCaring and GoFundMe. Such an approach is used to deal with a personal calamity like economic crisis, a family member having cancer or a house burned down. People respond generously to such causes.
Kickstarter is used by inventors and entrepreneurs to raise millions for development and production of services, products or devices like Coolest Cooler and Pebble Watch.
What are the Risks?
Crowdfunding is an emerging concept and investing in young projects can be risky. Here are the main risks associated with investment-based crowdfunding:
- The business might fail. Many businesses fail in their first year so you could lose the money you invested.
- The return is not guaranteed. The value of shares might not rise and you may not receive any dividend.
- Selling the shares might be difficult. The shares being unlisted are not as easy to sell as you would sell shares of big companies.
- The crowdfunding platform might go bust. You can lose money if you had paid the crowdfunding website and it goes bust before investing your money in the business you are interested in.
This means you should only invest the money you can afford to lose. You should not invest more than 10 percent of the money you want to invest in a year.