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The Basics of Crowdfunding

The Basics of Crowdfunding

What it is: Crowdfunding is about persuading individuals to each give you a small donation -- $10, $50, $100, maybe more. Once you get thousands of donors, you have some serious cash on hand.

This has all become possible in recent years thanks to a proliferation of websites that allow nonprofits, artists, musicians -- and yes, businesses -- to raise money. This is the social media version of fundraising.

There are more than 600 crowdfunding platforms around the world, with fundraising reaching billions of dollars annually, according to the research firm Massolution.

Related: Crowdfunding's Growth Spurt Going Strong

How it works: The most common type of crowdfunding fundraising is using sites like Kickstarter and Indiegogo variety, where donations are sought in return for special rewards. That could mean free product or even a chance to be involved in designing the product or service.

It is also possible to use crowdfunding to assemble loans and royalty financing. The site LendingClub, for example, allows members to directly invest in and borrow from each other, with the claim that eliminating the banking middleman means "both sides can win" in the transactions. Royalty financing sites appear to be more rare, but the idea is to link business owners with investors who lend money for a guaranteed percentage of revenues for whatever the business is selling.

The holy grail is to sell company shares or ownership stakes in the company on crowdfunding sites, because it could be like a mini-IPO without the traditional hurdles. In the past, this has only been legal with accredited investors, people who each have more than $1 million in net worth or more than $200,000 in annual income.

The good news is that the Jumpstart Our Business Startups Act of 2012 allows stock to be sold to the general public over crowdfunding sites, but as of mid-2013, the SEC was still hammering out the rules.

Related: 3 Rules for Successful Crowdfunding

Upside: Crowdfunding provides another strategy for startups or early stage companies ready to take it to the next level -- such as rolling out a product or service. Before, a business owner was subject to the caprices of individual angel investors or bank loan officers. Now it is possible to pitch a business plan to the masses.

A successful crowdfunding round not only provides your business with needed cash, but creates a base of customers who feel as though they have a stake in the business' success.

Related: Raising Money Through Crowdfunding? Consider These Best Practices For Success

Downside: If you don't have an engaging story to tell, then your crowdfunding bid could be a flop. Sites such as Kickstarter don't collect money until a fundraising goal is reached, so that's still a lot of wasted time that could have been spent doing other things to grow the business.

It could be even worse if you meet your goal but then realize you underestimated how much money you needed. A business risks getting sued if it promises customers products or perks in return for donations, and then fails to deliver.

There is also an argument to be made that angel investors and even bank officers provide more than just money. They provide entrepreneurs with needed advice. Business owners miss out on such mentorship when they ignore traditional investors and turn to the crowd.

Here are more factors that can better ensure a successful crowdfunding campaign:

  • Have at least a small network of enthusiastic friends and family willing to help get the ball rolling by giving and urging others to give.
  • If you're giving out perks in return for money, make sure the perks are cool.
  • Present a serious business plan and an explanation of why the money will take your enterprise to the next level.
  • Demonstrate that you have your own skin in the game because of the personal funds you have already poured into the business.
  • Include a video pitch and keep it short and concise, with a call to action.
  • PBS includes different rewards for different levels of giving; so should you.
  • Be prepared to essentially live online, staying active on social media sites, until the crowdfunding campaign is complete.

Related: How to Prepare an Effective Crowdfunding Pitch

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