This model of financing is known as crowdfunding—the process of generating capital from a number of different individuals who want to support a company.
But the type of crowdfunding offered by websites like Kickstarter is only one of several types of crowdfunding. Rewards-based, peer-to-peer and equity crowdfunding are just a few of the most popular forms of crowdfunding that small businesses can utilize to grow.
What are the differences? How can these different types of financing be used?
Let's learn how you can utilize the different types of crowdfunding to generate financing for your small business.
Crowdfunding: The Basics
As mentioned above, crowdfunding is simply the practice of gathering funding from a large number of individuals.
It can be a great method for small businesses to get as much funding as they need without having to rely on generous donations from high-value investors. After all, it’s often easier for businesses to generate $5 donations from 1,000 individuals than it is to get one person to donate $5,000.
Crowdfunding gives small businesses access to a much larger pool of potential investors than traditional methods.
Types of Crowdfunding
The basic idea behind crowdfunding is very simple. However, there are several different types of crowdfunding. Each type has its own advantages and disadvantages, but the general idea is still the same.
Let’s take a look at three of the most common types: Rewards-based, peer-to-peer and equity crowdfunding.
Rewards-based crowdfunding is likely the type that you’re most familiar with. It’s the same model used by popular crowdfunding websites like Kickstarter.
This method of financing allows any interested individual to pledge money to a company or product in exchange for rewards. Rewards are often tiered—meaning, the rewards for larger donations are more valuable.
For example, if a company sets up a crowdfunding campaign to develop a new video game, it might offer early access to all donors. Meanwhile, larger contributions may be rewarded with apparel and merchandise in addition to the early access.
This model gives potential investors an extra incentive to contribute.
Peer-to-peer crowdfunding is a little bit different.
The peer-to-peer model is more comparable to traditional financing methods. However, instead of borrowing from banks and other lenders, small businesses can borrow from a network of individual investors.
Lending Club is one of the leaders in this space. It’s essentially a marketplace for individuals to lend money to other individuals. Borrowers can access a large pool of independent investors, and investors can create a diverse lending portfolio.
Equity crowdfunding is less popular than the two methods above. The primary difference between equity crowdfunding and other types of crowdfunding is that this method involves the sale of securities, such as shares, equity, debt, etc.
This gives contributors the opportunity to make a real investment in a start-up and become a shareholder. Instead of receiving rewards, they purchase a portion of the company.
Is Crowdfunding Right for Your Small Business?
Crowdfunding can be a great option for any small business—particularly for small businesses struggling to secure financing via traditional routes.
Through this type of financing, small businesses can generate millions of dollars. Take a look at some of Kickstarter’s largest campaigns. Pebble Time, for example, is a smartwatch company that generated over $20 million from its crowdfunding campaign.
The type of crowdfunding you utilize, though, may depend on your business.
For example, rewards-based crowdfunding is great for companies that make a product or offer a service that is marketed to a large audience and can be used on a daily basis. This would create the potential to offer attractive rewards to contributors without having to give up shares.
However, companies that don’t target the general population may find more success in equity crowdfunding. For example, a cybersecurity company likely wouldn’t be able to offer attractive rewards. However, cybersecurity is a profitable, growing industry that may attract more long-term investors.
If you are having trouble generating capital from private investors and firms, or traditional methods of funding can’t offer as much money as you need, crowdfunding can be a great alternative.
Once you understand what crowdfunding is and how the different types of crowdfunding apply to different businesses, you can easily create a campaign through one of the websites mentioned above to start raising money for your small business.