Crowdfunding Types – The Right Tool for the Right Job
Recently we are seeing a lot equity crowdfunding marketing for campaigns that are anything but. ‘That means it’s high time for a review of crowdfunding types. We’ll take you on a tour of the intricate and fascinating world of crowdfunding to clear up confusion and answer all of those questions.
Crowdfunding Types – An Overview
When many people hear the word crowdfunding, they think of rewards or donation crowdfunding like those found on Indiegogo, Kickstarter, or GoFundMe. That’s understandable since those were the only legal forms of crowdfunding for many years and still remain wildly popular and well-known amng the masses.
While these two methods of crowdfunding have been around for a long time, it’s only recently that they reached their pinnacle of popularity thanks to the internet. It’s possible to end up with donors you’ve never met or solicited, simply because they happened to come across your campaign online. Twenty years ago, that would have been unheard of!
Equity Crowdfunding for retail investors recently as been around for over ten years—but even with that milestone under its belt, it’s still relatively new to the scene. But what came before equity crowdfunding? What pushed the market demand for this type of investing? And why is equity crowdfunding important to the investing market as we know it to
Equity Crowdfunding Origins
In 2012, then-President Obama signed the JOBS Act into law, launching a new branch of crowdfunding: equity. Prior to this legislation, only venture capital firms, hedge funds, or certified angel investors were legally allowed to invest in private startups.
The JOBS Act was then expanded in 2016 to include provisions that would allow non-accredited or retail investors to invest in these pre-IPO companies. That means in the grand scheme of things, equity crowdfunding is still in its infancy!
What About Debt Crowdfunding?
Whereas equity crowdfunding gives equity in exchange for investments and is not considered a debt in a company’s books, debt crowdfunding is just that—debt. Companies sign a legally binding agreement with investors to pay back investments with interest. The only way to break the contract is by filing for bankruptcy.
Debt crowdfunding is not considered riskier than other forms of crowdfunding, making it a viable option for companies that might not have traction enough to launch an equity raise. And because a company is asking for small investments from a wide pool of investors, it’s potentially much easier to get funding than from a bank.
Advocates of debt crowdfunding say it offers more favorable terms, lower interest rates, quicker approval times, and a simpler application process than other types of debt financing. However, there is no oversight to debt crowdfunding, and there is no statistical evidence that the contracted terms will be more favorable.
Is your head spinning from all these different types yet?
How Does Equity Fit In?
The wealth disparity in the United States is massive, well-documented, and all but irrefutable. Equity crowdfunding was created in an effort to change that. In fact, equity crowdfunding has likely made some of the greatest steps towards financial democracy the world has ever seen—no exaggeration!
Venture capitalists (VCs) and angel investors have long understood the way to make the most money from investing in a company is to invest before the company’s growth phase. By the time most people are purchasing on the stock market, VCs and angels are exiting with full pockets.
Generally, a VC or angel will thoroughly vet a company by combing through its financials, checking its market viability, calculating its transferable value, considering the company’s competition, and interviewing its management team. If the company seems as though it will achieve large returns based on the firm’s investigation, the company can get massive capital influxes—and the investor then earns a lot of money if the company is successful.
Since the legalization of equity crowdfunding, basically everyone can potentially earn a lot of money from investing in those same startups. However, risks are substantial. Other than age limits (investors must be 18 or older) and some location limits (many U.S. funding platforms do not accept investments from the U.K. or Canada due to securities laws), there’s nothing stopping the average person from investing and achieving the same high returns as a VC or angel.
It should be noted that it’s statistically improbable that a retail investor will earn enough returns to buy an island or retire early. The annual investment cap for unaccredited investors is $2,000 or 5% of their income, whichever is greater—far below the amount it would take to receive 7-figure returns.
Why the Choice in Crowdfunding Types Matter
In 2012, virtual reality tech startup Oculus Rift launched a rewards crowdfunding campaign on Kickstarter. For a minimum investment of just $300, investors would enable Oculus Rift to develop their headset, and in exchange would receive a headset once it made its market debut.
Though it wasn’t one of the most successful campaigns of all time, it garnered a cool $2.5 million in investments—more than enough to launch Oculus Rift into the company as we know it today. It could even be said that without their reward investors, Oculus Rift wouldn’t have made it through the valley of death (the period of $0 revenue when a startup’s costs outpace their sales).
Then, just two years after the close of the campaign that put them on the map, Oculus Rift sold an ownership stake to Facebook (now Meta)…for $2 BILLION. But what happened to the investors who funded Oculus Rift’s first batch of headsets?
Well…they got their headsets—and that’s all. Lots of backers were understandably upset. Quite a few were furious.
At the time, equity crowdfunding wasn’t yet legal for unaccredited investors. Because this was a rewards crowdfunding campaign, investors were not owed a cut of profits from the sale—even though their investments arguably drove Oculus Rift to that sale and all but guaranteed their success.
By some estimates, those $300 investments would have been worth upwards of $20,000 apiece had investors been able to invest for equity instead of merely for rewards. See how important it is to be clear on crowdfunding types?
And that’s why equity crowdfunding is important to the market. Everyone deserves to get returns for investing in startups, and with equity crowdfunding they can.
But crowdfunding itself is far from being a new concept; in fact, instances of it have been recorded for centuries…
In the early days of crowdfunding, the only legal incentive for attracting money was to offer some form of reward. And today, many microbusinesses continue to use rewards crowdfunding as seed funding for their projects. A reward could be the finished product, a downloadable copy of the movie or video ae and so on.
The rewards crowdfunding process is reasonably simple and unregulated by governing bodies, although each funding portal will likely have their own regulations. Founders create a campaign page by describing their project and fundraising goal on their chosen platform. As with all crowdfunding, they must run a robust marketing campaign to drive the crowd to their page. Then, in return for donations, the business provides rewards.
For example, a comic book author might have reward tiers such as:
- $10 donors will receive a digital copy of the comic
- $50 donors will receive both a signed physical and digital copy of the comic
- $100 donors will receive previous tiers, plus an exclusive T-shirt with the comic’s main character and title on it
- $150 donors will receive previous tiers, plus a character designed to look like them in the finished comic
Meanwhile, the money raised will go towards product development costs such as materials, equipment, designers, writers, or marketing to announce the product’s release.
Reward Crowdfunding Statistics
According to NerdWallet, there are about 19X as many rewards campaigns as equity campaigns. With complicated barriers to entry in equity crowdfunding ad virtually none for reward crowdfunding this trend is unlikely to change any time soon.
Fewer than a quarter (22.9%) of all rewards crowdfunding campaigns end up being successful
However, of that 22.9%, nearly three-quarters (78%) exceed their funding goals
The average rewards crowdfunding campaign earns $5,270
With nearly $7.5 billion cash raised on Kickstarter alone, reward crowdfunding remains the king of crowdfunding types.
Donation crowdfunding operates exactly how it sounds: donation only. Donors do not receive anything for their money other than the feeling of doing good in the world—which is sometimes incentive enough to fund massive campaigns!
The process of launching a donation crowdfunding campaign is very similar to rewards crowdfunding, and is similarly unregulated. After creating a campaign page detailing the reason people should donate money—often to fund medical procedures or social justice causes in the United States—the person launching the campaign then advertises it to attract donations. Without proper marketing, donation crowdfunding campaigns are statistically much more likely to fail.
Donation Crowdfunding Statistics
Donation crowdfunding has raised over $10 billion from 130+ million donations worldwide
A new donation fundraiser is started every eight seconds
Mostly due to the overwhelming number of campaigns launched daily, donation crowdfunding has the highest failure rate—91% in 2021
16% of campaigns receive no donations at all
$4,000,000 is raised daily on GoFundMe, the world’s largest donation crowdfunding platform
Ready to Crowdfund?
If you’re an entrepreneur thinking of launching a crowdfunding campaign, seek professional assistance.