Every Entrepreneur Should Know These 3 Essentials About Crowdfunding

What you may not know about this emerging industry could be keeping you back from opportunities.

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By Matthew Toren

Opinions expressed by Entrepreneur contributors are their own.

Over the last few years, a myriad of online platforms for lending money, funding projects and sourcing information have popped up across the Internet. With so many surface similarities, it's easy to see why you might get a little confused.

Is Kiva a crowfunding platform? What does LendingClub do? What is crowdsourcing and is that the same thing as crowdfunding? They may seem alike, but there are big differences between these new platforms that you should know.

Related: What Does a Multibillion-Dollar Corporation Want With Crowdfunding?

Here are the three essential things every entrepreneur should know about crowdfunding.

1. It's not microfinancing. You've probably already heard of Kiva, which connects individuals with money to people in developing countries who could use a small loan to help their businesses. Loans can be as small as $25 and are repaid (albeit with no interest) to the individual who lent the money.

Kiva is a microfinance social movement trying to connect small-business owners in developing countries (most are women) to capital they otherwise wouldn't be able to access. That sounds a lot like crowdfunding, right? Well, it's not.

Why is Kiva not crowdfunding? Because microfinance exists with a social improvement purpose: to lend money and provide opportunities to others. It's the concept of Nobel Peace Prize recipient Muhammad Yunus.

From his own experience growing up in Bangladesh, he realized many wanted to run a business and raise themselves out of poverty, but lacked the initial funding to get a venture started. The idea of microfinance to extend loans to emerging entrepreneurs who were too poor to qualify for traditional bank loans was a way Yunus saw to improve lives. He tested his own idea by creating Grameen Bank, which does exactly that.

Kiva, among others, followed and the microfinance movement began.

2. It's not crowdsourcing. Crowdsourcing and crowdfunding sound alike, but they're very different.

The idea behind crowdsourcing is to bring together people for the improvement of ideas or projects. It's the idea that the community, the whole, is better and can accomplish more than the individual.

Probably the clearest and best example of crowdsourcing is Wikipedia. You use it all the time, you may have even contributed to an entry, but it's all sourced and written by individuals who want to contribute to the community source.

With crowdsourcing, it's about sourcing and sharing in the benefits of knowledge, instead of funding.

3. Prizes, debt or equity? Crowdfunding is individuals collectively pooling money to fund projects or ideas. In many ways this "new" concept is quite old.

In fact, if you think about it, taxes are in essence the original crowdfunding. Sure, they're compulsory, but the idea is still the same: individuals contributing what they can into a pool of funds to then put toward the support of a common goal or project (think roads, health care, defense, etc). If you can wrap your head around taxes, then you'll get the idea behind crowdfunding.

Related: Potential Game Changer for Funding Awaits Final Approval From SEC

Within the crowdfunding space are the massively popular platforms Indiegogo and Kickstarter. Both allow entrepreneurs, artists, musicians and anyone else to pitch the community to fund a project.

Usually there's some kind of prize or reward to funders for the amount of money they supply to the project. While that's exciting, what's really revolutionary is the way crowdfunding can now be used to invest. Previous to the JOBS act, there were strict limitations around funding.

Now companies that fall under certain categories of SEC's Rule 506 regulations have the ability to openly seek accreditation, and in some circumstances unaccredited investors. Why does that matter? Previously you were only able to spend your money in a crowdfunding platform in exchange for a prize or reward. Likewise an investment company was not able to openly announce to the public they had deals seeking funding.

With the loosening of the "general solicitation" requirements in the SEC rules, there are now plenty of up-and-coming investment platforms trying to revolutionize the funding, lending and investing industry (think of what Uber did for transportation, or Airbnb did for hospitality).

However, not all of these new investment crowdfunding platforms are built alike. Some focus on business investing, others on real estate note lending and still others on things like consumer lending or equity investment.

For example, AssetAvenue allows accredited investors to pool their investment money with others to fund notes on commercial real estate opportunities. That means as an investor on their platform, you're essentially the lender.

Another wildly popular option in the crowdfunding and peer-to-peer lending space is LendingClub. There, you help people refinance their consumer debt by providing small, short-term consumer loans. You invest with others and own a portion of the loan extended to a consumer.

One more example is Fundable, which allows you to act like a venture capitalist and invest in businesses in exchange for a share of the equity.

What crowdfunding can do for you. There are things to pay attention to when investing, such as whether platforms require accreditation status and whether you're funding debt or equity, so you should check with your own tax professional first before investing.

However, the important takeaway for entrepreneurs is to understand what crowdfunding is and what it is doing to open up new ways of investment and new ways of funding for you and your business. Crowdfunding as an investment model is revolutionizing the way lending and borrowing happens.

If you're feeling wary of new sites, that's fine, but try to remember back to the first time you heard of Expedia or Travelocity. Odds are good you were still booking your travel through the airline's 800 number or your local travel agent at the time.

Now you're probably totally comfortable transacting your travel online now, so just think how your investing and borrowing could change. Crowdfunding is proving to be a legitimate and stable investment option that is poised to not only to stay in the game, but also dominate and topple antiquated industry models.

Related: 3 Other Ways Entrepreneurs Can Use Crowdfunding

Matthew Toren

Serial Entrepreneur, Mentor and co-founder of YoungEntrepreneur.com

Matthew Toren is a serial entrepreneur, mentor, investor and co-founder of YoungEntrepreneur.com. He is co-author, with his brother Adam, of Kidpreneurs and Small Business, BIG Vision: Lessons on How to Dominate Your Market from Self-Made Entrepreneurs Who Did it Right (Wiley). He's based in Vancouver, B.C.

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