What is crowdfunding? Everything you need to know

Crowdfunding, sometimes called crowdsourcing, is a way to raise money—typically online—by collecting funds from a large group of people, referred to as backers or investors.

Keep reading to learn more about crowdfunding, the different types of campaigns available and whether this is the right move for your company.

What you’ll learn:

• Crowdfunding is a way to raise capital for your business by collecting funds from family, friends, community members and investors.

• There are several types of crowdfunding campaigns, such as equity-based, reward-based, donation-based and debt-based crowdfunding.

• If crowdfunding isn’t the right option for your business, you could consider alternative financing options—like a business credit card—to support your company’s growth.

Crowdfunding is an alternative financing method that helps businesses raise capital from a broad online audience. By promoting a business idea or project on a crowdfunding platform, entrepreneurs can secure funding from many contributors rather than relying solely on loans, venture capital or other traditional funding sources.

Businesses can use capital raised through crowdfunding to cover the costs of launching a new product or service. Some startups also use crowdfunding campaigns to help cover the initial costs of starting a business.

Crowdfunding is generally categorized into four main types: equity, rewards, donation and debt. The best option depends on your business’s specific needs.

Equity crowdfunding enables startups and small businesses to secure funding from a large pool of investors in exchange for company shares. 

• Pros: Because equity-based crowdfunding gives investors a vested interest in the company, it can lead to long-term relationships and potentially open the door to their expertise and networks.

• Cons: Equity crowdfunding offerings are subject to securities laws and regulatory requirements. And because investors receive equity ownership in the company, it’s important to consider the risk of ownership dilution—particularly if the business raises additional equity financing in the future.

• Best for: Early-stage startups.

Rewards-based crowdfunding is a fundraising model in which supporters contribute money to a business or project in exchange for nonmonetary rewards such as exclusive products or early access to new releases.

• Pros: Typically, owners choose rewards-based crowdfunding to keep their ownership stake undiluted. It’s also a good option for testing a product or service, as backer feedback can provide valuable insights to refine your go-to-market strategy.

• Cons: Since this type of campaign usually runs on a crowdfunding platform, it’s important to consider that platforms typically charge a fee based on the amount of funds raised. And depending on the platform, you may not receive any of the capital if the funding goal isn’t met.

• Best for: Creative endeavors and product launches.

Donation-based crowdfunding is a fundraising model in which supporters give money to a cause, project or individual without expecting financial repayment or material benefits.

• Pros: Since donors don’t receive equity or rewards in exchange for their contributions, organizations and individuals can raise funds without giving up ownership or fulfilling product-related obligations. It can also be an effective way to rally community support around a meaningful mission or cause.

• Cons: Donation-based crowdfunding is typically most successful for charitable, community-driven or mission-focused initiatives. For-profit businesses may find it more challenging to attract donations unless they have a compelling story or social impact component. Campaign success can also depend heavily on marketing and outreach efforts.

• Best for: Nonprofits, charitable causes and community projects.

Debt-based crowdfunding, sometimes referred to as peer-to-peer (P2P) lending, works almost like a business loan. With this style of crowdfunding, you borrow funds to be repaid, plus interest, over a set period of time. But instead of receiving the money from a bank, lenders lend you the funds themselves. 

• Pros: This method allows you to maintain company ownership because your financial obligation to lenders ends once the loan is repaid. And because the repayment schedule is usually fixed, it can be more predictable than that of other crowdfunding campaigns.

• Cons: Debt-based crowdfunding can cost more than other campaigns because you typically owe interest to lenders. Plus, if you miss payments, it could hurt your credit score. And if you used collateral to secure the loan and can’t repay it, your assets could be at risk.

• Best for: Businesses seeking working capital without giving up equity or control.

If you think crowdfunding fits into your overall business plan, there are a few general steps you can take to get started, from choosing the right platform and setting funding goals to building your campaign and attracting supporters:

There are various crowdfunding platforms available, and the best platform for you depends on the campaign you’re running. Here are a few things to keep in mind when you’re searching for a crowdfunding platform:

• Research fees: Review the fee structures and any additional platform costs. 

• Evaluate fit: Consider your business’s industry and the platform’s target audience.

• Review requirements: Determine whether the platform requires you to reach 100% of your campaign goal to keep the funds you’ve raised.

Once you’ve decided on the crowdfunding platform that’s best for you, it’s time to determine your budget and set campaign goals. 

Before launching a crowdfunding campaign, calculate the full amount of capital you’ll need by factoring in:

• Operational expenses

• Platform fees

• Delivery costs

• Marketing and promotional expenses

Establishing a realistic budget and campaign goals can help ensure your campaign is financially viable.

A successful crowdfunding campaign typically combines compelling storytelling with a clear purpose.

Whether your pitch is presented in a video or written format, it should explain:

• What inspired the project

• The project’s goals

• The project’s intended impact

• How the funds will be used

The more effectively you communicate your vision, the easier it is for supporters to understand the value of your project.

Prelaunch marketing is a critical part of crowdfunding success. You can build an audience before your campaign launches by collecting email subscribers and generating awareness. Then use social media, email campaigns and community engagement to drive traffic and maintain momentum throughout the fundraising period.

There are some disadvantages of crowdfunding to keep in mind, such as additional costs, funding uncertainty, time commitments and increased competition from other campaigns.

• Hidden costs: There are often additional costs and fees to consider that can affect your overall campaign goals. 

• No guarantees: Crowdfunding carries some risk, as you can’t be certain how much capital you’ll raise during the campaign. And if you choose an all-or-nothing platform, any funds raised will be returned to contributors if the goal isn’t met. 

• Time intensive: Compared to other funding sources, crowdfunding can be a longer process for securing capital. Not only does it require ample planning and preparation to launch a successful campaign, but you’ll likely need to invest some time in ongoing promotional efforts. You’ll also need to consider the amount of work required to follow up with potential investors, contributors or supporters.

• Apprehensive backers: Prospective backers may be hesitant to donate through a third-party platform rather than sending funds directly.

• Tight competition: Crowdfunding has become an extremely popular source of fundraising, with countless new campaigns launching every day. Depending on your industry and the type of crowdfunding campaign, there might be market saturation, which could make securing funding more difficult.

For entrepreneurs, exploring different avenues for business credit is an important step when expanding your business. If crowdfunding isn’t the right option for your organization, here are a few financing alternatives to consider:

• Business credit cards: Like personal credit cards, business credit cards are revolving lines of credit that can be borrowed from and repaid repeatedly. 

• Business lines of credit: A business line of credit works similarly to a business credit card in the sense that you can draw funds up to a certain limit and repay and borrow funds as needed. But a business line of credit usually has a draw period that ends after a set period of time.

• Business loans: You could try securing funding from a bank or credit union in the form of a business loan. This type of financing can work for business owners who are comfortable repaying a loan, plus interest, over a set period through fixed payments. 

Want to learn more? Below are frequently asked questions about crowdfunding that business owners, founders and entrepreneurs may have.

Crowdfunding can be a great way to secure funding from a large group of contributors, backers or investors who align with your business goals and mission. But choosing this type of funding doesn’t guarantee you’ll secure financing, and it can require time and effort to run a campaign. If you’re interested in other company financing options—like a business credit card—you could consider business credit cards from Capital One Business and get pre-approved today, with no harm to your personal credit score.