Crowdfunding: Meaning, Types, Sites and How It Works?

Traditional ways of raising capital for a new business, venture, or project are limited. You could ask for money from your friends or family, secure collateral-free Business Loan from reliable lending institutions like Hero FinCorp, or persuade angel investors or venture capital funds to invest in your business. 

You could also invest your savings over the years into the business. However, over the last few years, a new business funding option has emerged for businesses looking for capital: crowdfunding. 

Simply put, it is the process of raising and pooling funds from numerous individuals to fund a project. Each investor invests a small amount into the fund, hoping to receive financial or non-financial benefits. The following sections will explain what this type of funding is, how it works, and take a look at its types and popular sites.

What is Crowdfunding?

Crowdfunding is collecting small amounts of money from several individuals to fund a new project. It exploits vast networks of people through crowdfunding platforms and social media to bring entrepreneurs and investors together. While looking for funds to expand a business, the owners can increase their funding source beyond the traditional circles of relatives, savings, angel investors, and venture capitalists.

How Does Crowdfunding Work?

Crowdfunding for business is a means of funding from sources beyond finance companies. Entrepreneurs looking for funds through this method must register at an official crowdfunding website. Small investors planning to invest in new businesses also register at these sites. Therefore, crowdfunding websites become the medium where entrepreneurs and investors meet each other. After registering, the entrepreneurs put the business concept and project through the website, allowing potential investors to make their investment decision.

Potential investors can sponsor the minimum amount requested if they show interest. In case of over-applications, the investors get back the excess money. After receiving the funds, the entrepreneur must pay a percentage of the funds raised as a fee to the crowdfunding platform. Later, they must share the profits generated with the investors as a return on their investment.

Different Types of Crowdfunding

While crowdfunding can be of different types, each raises capital from interested investors. Here is a breakdown of each:

Peer-to-Peer Lending

Traditionally, this fundraising campaign means borrowing small amounts from friends or relatives. Some crowdfunding sites also follow this concept. Fund seekers can access capital other than conventional banking channels through these platforms. Small investors interested in lending money to others and earning interest can create their loan portfolio quickly through these platforms.

Equity Crowdfunding

When investors contribute to equity-based campaigns, they become partial company owners by getting equity shares in return for their capital. Since the contributors become equity owners in the company, they receive financial returns on their investments in the form of dividends. The company shares they receive depend on the size of their contribution.

Rewards-Based Crowdfunding

Rewards-based campaigns involve people contributing to a project expecting a reward in return, mostly the product or service the company offers. Although the investors get a reward, it is a form of donation-based funding since it involves no equity or financial return. The reward usually depends on the contribution size: the higher the contribution, the bigger the prize.

Donation-Based Crowdfunding

This type of crowdfunding includes running a fundraising campaign for a person or company for nothing in return. For instance, if a business owner creates a campaign to purchase new machinery or equipment, individuals donate money out of support to the business expecting nothing in return. Other common examples include raising funds for disaster relief, medical bills, charities, and non-profits.

Profit-Sharing / Revenue-Sharing

Profit sharing or revenue sharing is similar to an equity-based crowdfunding campaign. When investors contribute to these campaigns, they purchase a portion of the business's profits and receive returns when it succeeds.

Debt-Securities Crowdfunding

Instead of accepting donations, raising funds through debt securities means borrowing loans from a group of investors. Similar to most loan types of funding for businesses, the borrowers have to repay them to the lenders in addition to interest. However, one benefit of raising funds through crowdfunding websites is that they give much faster access to the required capital.

Hybrid Models

A hybrid model allows capital seekers to combine and take advantage of more than one type of crowdfunding campaign.

List of Popular Crowdfunding Websites

Several crowdfunding sites allow entrepreneurs to raise funds to kick off their business. Here are a few top sites one may use to grow their company:

1. TheHotStart: Launched in 2014, TheHotStart helps Indian businesses with several projects, including education, food & beverage, medical care, etc. The platform has several features and tools to let entrepreneurs create the best products. It also has advisors to guide the project while raising the required money. It charges 10% on the raised funds.

2. Indiegogo: The platform allows businesses to reach a global audience with fixed and flexible fundraising options. It has a community-based approach that makes the process easier. The fixed type has an all-or-nothing option that provides contributors with their investment even if the project fails to meet its goal. Entrepreneurs can keep a percentage of the raised funds in the flexible funding option.

3. Start51: This is an idea-based platform ideal for start-ups. With a focus on raising easy funds for entrepreneurs, the site charges 5% of the raised funds. In return, it gives them access to a broad network of investors.

4. GoFundMe: Millions of fundraisers use this platform to raise funds for their causes. Donors can choose the campaign they want to support and donate through online payment processors. The best thing is that GoFundMe does not charge any cut of the donations received. It allows fundraisers to sign up using their email address, set a fundraising goal, add videos or photos, and create a campaign.

5. Ketto: Ketto is a Mumbai-based platform with various campaigns to select from, including education, animal welfare, personal care, sports, etc. Its best features include tax benefits to the contributors, a cash pick facility, and a separate section for urgent fund requirements.

Advantages and Disadvantages of Crowdfunding

Crowdfunding platforms have helped several budding entrepreneurs set up their businesses and expand. Let us look at the pros and cons of the funding option.

Conclusion

Crowdfunding is an efficient way to raise new business funding. If a company cannot access traditional loans or investors, it can launch a campaign on crowdfunding platforms and get the required funding from the public. However, apart from the benefits, this capital raising procedure also has cons. So, once received, borrowers should use the funds wisely to make their business successful and deliver promised returns to their investors. This can help build a strong business image.

Frequently Asked Questions

1. What Is Crowdfunding, and How It Works?

Crowdfunding is the process of raising capital from various investors. When a business owner launches a fundraising campaign, it receives funds from several investors to fulfil its monetary requirement. Such campaigns may raise donations for the business, or the owners must return the raised amount to the investors with a profit.

2. Which Is the No 1 Crowdfunding Platform in India?

Ketto is one of the best crowdfunding platforms in India. It offers the contributors a wide range of fundraising campaigns with tax benefits. Since its launch in 2012, several NGOs have used this platform to raise funds for various causes. Many prominent figures like Amitabh Bachchan and Kailash Satyarthi also use Ketto to raise funds. Giants like Radio City, Viacom 18, Pune Super Giants, Yes Bank, etc., have partnered with the platform for their social and corporate initiatives.

3. Is Crowdfunding a Good Way to Make Money?

Crowdfunding is an excellent way to raise funds for a business rather than borrowing a Business Loan or attracting venture capital or angel investors. It pools money from various investors without any security, formalities, or documentation.

4. Do You Pay Back Crowdfunding?

Crowdfunding campaigns are of different types: donation-based, equity-based, peer-to-peer lending, equity-based, debt-based, etc. Donation-based campaigns do not deliver any returns to the contributors. However, borrowers must pay back debt-based funds to the investors. Other types also generate some kind of return based on the fund size.

5. Is Crowdfunding Taxable in India?

Tax guidelines give complete exemption to non-profit establishments raising capital through crowdfunding. However, receiving funds through online platforms becomes taxable.