What is crowdfunding?

February 8th, 2023 .

Authored by Hiscox Experts.

8 min read

Crowdfunding is an innovative way for businesses to raise money online from a large group of people – typically members of the public, rather than just a few investors.

The rise of online platforms has enabled this type of alternative funding to gain popularity, with the crowdfunding market predicted to grow by $196 billion by 2025 [1]. This projected rise will come after just seven full years of Regulation Crowdfunding, which began in 2017 [2].

While it may seem an exciting time to begin crowdfunding as a business, there are advantages and disadvantages to consider. In our guide, we’ll cover everything you need to know about what crowdfunding is and how it works, plus how you can get involved as a small business.

What is crowdfunding and how does it work?

When businesses, charities or individuals set up crowdfunding pages, they’re able to connect with thousands of potential investors to fund projects and operations. Money can be sent and collected in just a few clicks, creating endless opportunities for businesses of all types.

From banking giants to viral tech companies, a variety of businesses across a diverse range of industries have found success on crowdfunding platforms.

Today, crowdfunding success stories are becoming more common, with some campaigns even crossing over into mainstream news and media channels.

However, the crowdfunding process might not be for everyone, and involves much more than simply creating a donations page and watching the money roll in.

From applying to a platform to pitching your idea and creating an effective marketing plan, building a successful crowdfunding campaign takes a lot of time and effort.

What are the main types of crowdfunding?

Another thing to decide before you start is which crowdfunding type to use. There are multiple ways to generate funding, used by businesses, charities and individuals.

These include:

Loan-based or peer-to-peer crowdfunding

Businesses that offer their investors something in return for their support often use this option. Investors are usually repaid the amount they’ve invested plus interest when the business is able to do so [3]. Essentially, the crowdfunding business is lent money from multiple investors, similar to how a bank would.

Investment-based crowdfunding

This is another type of funding used mainly by businesses that offer investors something in return for their contributions. Those who fund the venture buy investments in shares and bonds [4] with the hope of being reimbursed when the project becomes successful.

Reward-based crowdfunding

Reward-based crowdfunding is a popular tactic used by businesses, charities and individuals. As you’d expect from the name, investors are promised rewards in the form of goods and services as an incentive6. For example, this could be first access to the product before it is made public, behind-the-scenes information, or one-of-a-kind items.

Donation-based crowdfunding

This is possibly the most straightforward type of crowdfunding. Here, people give money to causes, projects or businesses they want to support without the promise of anything in return [4].

If you’re using crowdfunding to launch a business you may also want to know how to register a business in the UK.

Crowdfunding: advantages and disadvantages

When looking at how crowdfunding works, it can be exciting when you start to think about the possibilities for the future of your business – especially as it’s usually free or costs very little to start a campaign.

However, before you begin your crowdfunding journey, let’s look at some of the advantages and disadvantages it might be beneficial to consider.

Crowdfunding advantages

There can be less risk compared to a traditional loan

When you use donation or reward-based crowdfunding tactics, the people who invest in your company are not expecting to be ‘repaid’ in any way, except maybe with some freebies or priority access to your project.

Even with peer-to-peer or investment-based crowdfunding, investors pledge their money with the understanding that they will only be ‘rewarded’ if the venture meets its crowdfunding goal. In most cases, if you do not meet your funding goal, the platform will refund all of your backers [5]. However, always double-check the T&Cs of your chosen site to make sure this is the case.

It helps to market your business

An effective crowdfunding campaign outlines your business’ USPs (unique selling points) and markets the benefits of your specific brand and prospective project. You can take the opportunity to push your vision into the public eye, with many platforms incorporating seamless social media sharing options into their site.

You should also never underestimate the power of viral marketing. Famously, crowdfunding platforms have provided an excellent organic place for projects to reach both desired and previously untapped demographics – all via the power of online virality.

From cult card games to innovative video game tech, these once ‘bedroom idea’ projects illustrate the scope and potential of crowdfunding.

It provides opportunities for feedback and improvement

Naturally, crowdfunding campaigns create an organic conversation between you, as a brand, investors, and prospective customers. If people are investing their money in your project, they want to ensure it’s the best it can be.

While having so many eyes on your venture can be daunting, it also means people are more likely to spot any shortcomings and improvements – which can only benefit everybody. Any feedback is invaluable for new businesses or even experienced brands launching new projects.

Crowdfunding disadvantages

You won’t receive investment if you don’t reach your goal

Unfortunately for businesses, one of the draws for investors to crowdfunding is that their money will be returned if the project doesn’t reach its funding goal10. This means you won’t receive any of that investment if you fall short.

While it’s easy to start again, all the effort that went into your first campaign may be lost. You might also find that investors lose faith in the validity of your venture if it initially failed to reach its goal. Monetarily, you may not have necessarily ‘lost’ anything, bar your time – unless you decided to invest in paid social campaigns, for example.

It takes a lot to build a successful campaign

As we mentioned before, it takes more than simply setting up a crowdfunding page to make a successful campaign. In order to get any investment, you need to spend time skilfully generating online interest to ensure you meet your funding goal.

From creating effective marketing campaigns to keeping social media up to date, drumming up consistent interest in your brand or project can be quite hard work. Consider having a plan before you begin crowdfunding to ensure nothing is forgotten.

Your idea could be stolen

It’s difficult to legally protect an idea that’s not yet ‘real’ so, sometimes, you may find that copycats take ideas from crowdfunding sites and use them as their own. It’s a good idea to do your research on this matter before you get started, to make sure you have as much in place as you can to protect your property – such as patents.

Patents can help protect your ideas from being used and produced by others. When you launch a project on a crowdfunding platform, it doesn’t mean that it’s patented. However, some sites may have certain copyright regulations in place [6]. Just keep in mind that any projects published on these platforms are often considered ‘public domain’ [7].

Learn how to price a product or service

How do I start crowdfunding for my business?

Before you begin attracting investors and getting your idea off the ground, there are a few steps you’ll need to take to get started [8]:

Choose your platform. There are many different sites out there, so it’s a good idea to do your research to find the one that’s right for your business or project. Each site will have different regulations and fees, so take time to compare them.
You’ll have to fill in an application and await approval from the crowdfunding site. During this process, you’ll need to give personal and business information, so ensure you have this organised before you begin.
Pitch your project. This is where you need to describe how the funds will be used. Pitch your project, business or charity cause and try to make it as attractive as possible. Get ideas for winning pitches.
Build your page. Once approved, you’ll need to set a funding target and build your donations page. This is where investors will come to learn more about your business or project and pledge money. Ensure your target is reasonable and there are incentives to help your cause. Remember, if you don’t reach your goal, you won’t receive any of the money pledged.
Market your business or project. It’s not enough to create a crowdfunding page and expect the donations to start rolling in. You should push your project and market your brand to garner as much buzz as possible. A consistent online presence is key, as is creating relevant, shareable content. Learn more about digital marketing for small businesses.

Which crowdfunding site is best for my business?

Finding the right crowdfunding site for your business depends on why you’re raising funds. The best option will differ for each company and project, so it’s a good idea to do some platform window-shopping before you apply.

Crowdfunding platforms will differ in a variety of ways, including:

The fees they charge – some may be free while others may charge for their services.
Their application process – depending on what the site specialises in, some may involve an in-depth pitching process, while others may not.

The types of crowdfunding they offer – you’ll want to choose a platform that supports the type of funding you want. Whether that be peer-to-peer, investment or reward-based, for example.
Their eligibility criteria – some sites may only cater to specific business types, or those looking to raise certain amounts of money.

Want to explore other ways to fund your business? Read our guide to small business grants in the UK.

References

Disclaimer:
At Hiscox, we want to help your small business thrive. Our blog has many articles you may find relevant and useful as your business grows. But these articles aren’t professional advice. So, to find out more on a subject we cover here, please seek professional assistance.

Hiscox Experts

The Hiscox Experts are leaders valued for their experience within the insurance industry. Their specialisms include areas such as professional indemnity and public liability, across industries including media, technology, and broader professional services. All content authored by the Hiscox Experts is in line with our editorial guidelines.

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