How Does Crowdfunding Work?
When a project is short on cash, they often wonder about the potential of crowdfunding. It’s easy to see why, because crowdfunding can help a project raise money, while promoting themselves… at exactly the same time. But how does crowdfunding work?
This guide mostly covers “rewards crowdfunding” – as in, the type offered by sites like Kickstarter and Indiegogo.
Table of Contents
What Is Rewards Crowdfunding?
“Crowdfunding” refers to the practice of using the Internet to solicit money from large numbers of people who each contribute relatively small amounts towards the overall goal. The crowdfunding phenomenon is actually much broader than the subject of this article, so let’s take a moment to look at the different types of crowdfunding, and how does crowdfunding work, to distinguish rewards crowdfunding from the other kinds.
- Equity Crowdfunding – backers get shares of ownership in the company raising the funds
- Debt Crowdfunding – backers become small lenders, expecting the borrower to repay the money later
- Real Estate Crowdfunding – backers become partial-owners of real-estate properties
- Donation Crowdfunding – the money is given as charity, with no expectation of anything in return
- Rewards Crowdfunding – backers are promised a product or other perk in exchange for their pledge
All these varieties of “crowdfunding” are raising finance for projects from the collective efforts of many small backers. The differences lie in what is being funded, and what is being promised in return.
Equity crowdfunding, debt crowdfunding and real estate crowdfunding are all financial investments – backers stand to profit if the venture they entrust their money to performs well. Meanwhile, donation crowdfunding is given purely out of the kindness of the backer’s hearts to help those in need – for example for funding a medical procedure, pay for education, or for humanitarian relief efforts.
In rewards crowdfunding, backers are not motivated by financial returns, but it is not a ‘something for nothing’ proposition either. Creators get financial support for what they are trying to do, and in return backers are promised a “reward” from the creator such as a physical item, a digital download, or an experience. Pledging to a rewards crowdfunding campaign is a bit like being a customer – pre-ordering the item, before it has been made. Additionally, the creator may use the campaign as a way of seeking feedback from the crowd on what they are making. Receiving this kind of crowdsourced input on the final design means that rewards crowdfunding is about more than just the money – it’s about community-building and collaboration too.
Helping creative projects get off the ground is the best-known use of rewards crowdfunding. The rewards being offered tend to share certain characteristics. There should be something new and different about the project, it is best-suited to products which are cheap enough to encourage impulse-buys, and in order to take full advantage of the global online reach of crowdfunding, it is best if perks are deliverable to far-away locations. Additionally, some (but not all) rewards crowdfunding projects have a social impact or sustainability angle.
To give some concrete examples, here is a selection of projects which rewards crowdfunding has historically been particularly strong for:
- board games
- video games
- outdoor equipment
- sports gear
- travel accessories
- novelty gadgets
- drink bottles
- community projects
- artistic performances.
In summary, rewards crowdfunding has four elements to it:
1. Using the Internet…
2. …to raise money from a large number of small backers…
3. …for creative projects…
4. …by promising perks in exchange for the money pledged
How Does Crowdfunding Work?
So, rewards crowdfunding sees people go online to pledge cash towards creative projects, in return for the promise of rewards from the creator. But how does crowdfunding work, exactly?
Here are some key terms to become familiar with:
The websites which host campaigns for potential backers to view and pledge money towards. There are important differences between the various crowdfunding platforms, and understanding these is critical from a campaign creator’s point of view. There are almost always multiple live campaigns on each platform at a time.
The creators attempting to raise money. Campaigns use platforms to publish their pitch, where they explain their project and offer the promise of rewards to backers.
The individuals who pledge their money towards campaigns, and expect to receive rewards in return. Backers discover campaigns by visiting platforms.
If you have never seen a crowdfunding platform before and you are wondering how does crowdfunding work, it would be a very good idea to check one out, as it will provide context to this section.
Go to kickstarter.com or indiegogo.com (which are, by far, the world’s two largest rewards crowdfunding platforms), and navigate to the part of their website which shows campaigns seeking funding. Once you are at an individual campaign page, you will see there is some information about the project. Platforms differ, but you will probably get to see an introductory video, written information, images, animations, and background on the people behind the campaign. There is also an area where potential backers can ask questions and receive answers from the project founder.
Campaigns must set a funding goal, which is the target amount of money they are seeking to raise. Some crowdfunding platforms mandate the funding goal to be a fixed target, in which case it becomes the minimum amount of money necessary for the offer to be successful. If a campaign set a funding goal of US$20,000 with a fixed funding goal, but only US$15,000 was garnered from backers, then the campaign would fail and no money would be raised – not even the US$15,000. Other crowdfunding platforms allow campaigns to keep whatever money they raise, regardless of whether they make it all the way to their funding goal or not.
Campaigns must also set a deadline, which is the final date where the campaign closes and will not be able to accept any more money. If the project succeeds in reaching its funding goal before time expires, backers’ credit cards will be charged and the money will be delivered to the project creator (minus the platform’s fees).
Each campaign usually has several reward tiers on offer. The more money pledged, the greater the reward on offer. Different reward tiers can also be used to motivate urgent action – for example, by creating exclusive early bird offers only available to the first few backers.
Campaigns can get the attention of potential backers in two basic ways:
1. Through their own direct outreach – for example, through PR outreach or running paid advertising to their page
2. Through organic traffic – people browsing the crowdfunding platform who may never have heard of your campaign before, but it piques their interest and they click to learn more.
Related Article: Crowdfunding Public Relations – Tips To Get PR For Your Campaign
Getting significant organic traffic is the dream of campaign creators, because it is attention and money which the campaign creator did not have to generate through their own effort.
One thing to clear up right away: do not expect organic traffic from the crowdfunding platform to raise all the money for you. Just putting up a crowdfunding page will not result in the money just rolling in. The hyper-successful campaigns that raise big money do not achieve those results by accident – rather, it is the result of deliberate planning. You will only get the benefit of the organic traffic of the platform’s audience if you generate the initial momentum through your own direct outreach.
When you think about it, backers of crowdfunding campaigns are doing something rather unusual.
Normally products get delivered to the customer in fairly short order – days, or maybe weeks after being ordered. But rewards crowdfunding can have delivery dates which stretch out to several months, a year, or even more.
So, how does crowdfunding work differently? It may seem strange that in today’s world of instant gratification and overnight shipping that people are prepared to wait such a long time to receive their rewards. So let’s get to grips with the the rewards crowdfunding mindset, and what motivates backers to hand over their cash so far in advance.
1. To Get It Cheaper
A very clear reason to back a crowdfunding campaign is to get a discount from the price the product will be eventually sold for.
The discount needs to be generous, especially if customers are being asked to wait a long time for delivery. Broadly speaking, a 5% discount would be viewed as too insignificant, whereas discounts of the order of at least 20% are more compelling.
2. To Get It First
People will camp outside Apple stores in the days before a major new product release, just so they can be among the first to get their hands on the latest iPhone. For the same reason, promising crowdfunding backers access to your product before anyone else gets their hands on it can be a very compelling sell.
Note, if you promise backers early access, make sure you mean it! They will get very annoyed if they see the item they backed for sale elsewhere, before they have received it themselves.
3. To Get An Exclusive
Depending on the project, it may be possible to offer customization on the reward, which will not be available later. For instance, to get their name engraved on the product, or to get it in a unique color of their choosing.
A word of warning: many campaign creators caution against offering too many options in the rewards on offer, because it can become difficult to fulfill highly customized offers when it comes time to deliver.
4. To Support A Cause
Sometimes the line between rewards crowdfunding and donation crowdfunding becomes blurred – even reward crowdfunding can verge into the territory of charity. Even though rewards crowdfunding offer perks, some backers are not primarily thinking “what’s in it for me”. It might be more about the cause they are supporting. This is particularly true of social good projects and community projects.
The cause might also be your personal own story – friends and family might back a project to help someone they care about, even though they might not get much in return.
5. To Find Community
People can form tribes around brands and products – just look at Harley Davidson. More than being just about motorcycles, Harley is a lifestyle, and a way of like-minded people bonding over their shared passion.
As it applies to crowdfunding, finding community is particularly strong with board games. Backers like having a say in how the game turns out, and being able to tell their friends how they had a part in creating it.
So, what motivates backers? In the words of economists everywhere – it depends. But once you have decided on your project, When forming your campaign you will refer back to these backer motivations often when forming up your perks and campaign page copy.
Readers should now have a strong grasp on what rewards crowdfunding is and how does crowdfunding work. Now that the basics have been taken care of, check out this book on how you can execute a campaign of your own successfully.
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✓ How To Build Your Crowd, Even If You Don't Have One Yet
✓ The Differences Between Kickstarter vs Indiegogo
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