Understanding crowdfunding

What is Crowdfunding?
The definition from Forbes.com is “the practice of funding a project or venture by raising many small amounts of money from a large group of people, typically via the Internet.”

It started mainly as a way to solicit small donations for charitable causes and for creative projects such as CD music recording, low-budget movie and book publishing. It has mushroomed in recent years and is now used for a variety of purposes, including raising money to fund project development and business startups. There are more than 600 crowdfunding platforms around the world, with fundraising reaching billions of dollars annually, according to the research firm Massolution.

However, legal issues limit solicitations on most portals to requesting donations. A few portals do facilitate loans and royalty financing and have structured themselves to comply with federal and state lending laws. 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. Selling company stock is prohibited unless the site is specifically geared towards accredited investors as defined by the SEC.

How it Works
The most common type of crowdfunding fundraising is using sites like Kickstarter and Indiegogo, 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.

The web portals collect and disburse funds, charging a fee typically of about 5% of the money raised. Some portals forward all funds raised; others do not forward funds unless the requestor's minimum funding goal is met.

The most recent type of crowdfunding is Securities-based Equity Funding. This enables accredited investors to invest in companies, gain ownership, has the possibility of future returns and the investor becomes a shareholder in the company. The types of investment options are equity, convertible note or debt-based offerings. The top crowdfunding sites for investment-based are Crowdfunder and AngelList and for Debt-Based, SoMoLend.

Success Stories
Chicago designer Scott Wilson made history as one of the biggest successes to ever hit Kickstarter in 2010. His creation the TikTok and LunaTik wristbands, which converted the Apple iPod Nano into a watch, attracted 13,500 backers and almost a cool million in funding. He'd originally asked for just $15,000. With his initial success, TikTok and LunaTik are now sold by major retailers, including Amazon, Walmart and yes, even Apple.

Another Kickstarter success was Eric Migicovsky, founder of Peeble Technology, the company behind the Peeble smartwatch. He was hoping to raise $100,000. Instead the Kickstarter campaign, which ran from April to May 2012, generated more than $10 million from almost 69,000 backers. Within a few months, the Peeble smartwatch appeared in retail stores. In now sells for $150 at Best Buy stores and via AT&T. So far, he holds the title as the most funded project on Kickstarter.

Canary became the most successfully funded campaign in Indiegogo history. The company has a simple device packed with smart sensors that empowers you to keep your home safe and secure controlled through your mobile device. It set a goal of $100,000. Itmet that threshold before lunchtime on the first day and by the time its campaign ended 34 days later on Aug. 26, 2013, it had raised more than $1.9 million.

Five Suggestions for Successful Crowdfunding:

Clearly define your product and your goals.

Many people have amazing ideas but go into crowdfunding without fully defining their goals ahead of time. Are you building a single product, a group of products, a company, or is this just a fun side project? You will be in a better position to open up and present yourself to “the crowd” if you know and can articulate your goals. Spend the time to develop your brand or craft your bio prior to launch so you're not scrambling to figure it out when you open yourself up to the eyes of the Internet.

Have an intriguing, clear story.

One reason that people give you money is because your story touches people, so you need to be able to express very clearly what you are trying to do and why it is significant. Crowdfunding is built around relationships. It is a very human phenomenon. You have to be willing and prepared to put yourself in front of the crowd of investors and connect with them directly, through your video, your project description, your images, and your updates — everything. Potential investors need to see enough of your passion to think “Wow, I want to be a part of it.”

Spend money to make money.

Yes, your goal is to raise money. However, there are ingredients so critical to a successful crowdfunding campaign that they justify throwing down some cash. A powerful video is crucial and you might consider hiring a professional in this field. Spending money for PR assistance can also pay off. You want your campaign to hit the ground running so having a PR expert help you line up and manage media coverage and interviews prior to launch can make all the difference. Brand development, copywriting, and social media management might also be worth the investment.

Use an existing network.

The process of crowdfunding depends on trust and reputation, so you'll need a core inner group to vouch for you and help spread the word. Every successful crowdfunding campaign has an immediate first-degree network that jumps into that campaign. But this doesn't mean you need to have thousands of Facebook friends, you just need at least a small group that is willing to step out on your behalf to get it going.

Give cool perks.

In exchange for their money, you'll need to offer investors a reward, whether it's a sample, the ability to vote on how a product or service is designed, or an opportunity to get early access to a product or service before it hits the regular markets. Also, you'll want to offer multiple levels of perks to provide an incentive for a broader range of contributions.

Cheryl O'Neill Gowen is president and CEO of Alternative Funding Options. She works with business owners seeking cash flow from non-traditional sources, drawing on more than 30 years' experience in banking, financing and staffing. Contact her at:[email protected].