Oxford Dictionaries may have chosen “vape” as their 2014 “Word of the Year,” but for entrepreneurs, it should have been “crowdfunding.” And indeed, crowdfunding was added to Merriam-Webster’s Collegiate Dictionary for the first time last year.
So what is crowdfunding, exactly, and should you be doing it?
The Investopedia website defines the practice as “The use of small amounts of capital from a large number of individuals to finance a new business venture.” The SBA’s online course Crowdfunding for Entrepreneurs adds, “... with crowdfunding an entrepreneur can attract a ‘crowd of people’ each of whom takes a small stake in a business idea, by contributing towards an online funding target.”
But this dry, financial language belies the torrent of energy and innovation that this trend has unleashed. Look no further than the Coolest Cooler, Kickstarter’s most funded project to date. This Frankenstein piece of recreational gear combines an ice chest with a blender and Bluetooth speakers (among several other things) into one alluring package. And most importantly, its project page features a video compelling enough to blow away the original goal of $50,000, ultimately raising more than $13 million.
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It’s important to note that there are two types of crowdfunding: rewards-based and equity-based. Kickstarter and its brethren offer rewards-based crowdfunding, which means that contributors who kicked in the $180 for the Coolest Cooler received one of the first coolers off the production line, but no stock or ownership stake in the company. Kickstarter itself receives 5 percent of all successfully funded projects. Additionally, they use an all-or-nothing model, so if a project doesn’t hit the full amount, both investors and entrepreneurs are protected from loss and expectations.
Equity-based crowdfunding, on the other hand, gives a fraction of your company to each investor, versus a reward. This is a newer type of investment, which was created by the 2012 passage of the Jumpstart Our Business Startups Act. As of now, equity-based sites such as Crowdfunder.com allow for accredited investors to purchase equity in early-stage companies. Per Securities and Exchange Commission rules, an accredited investor is someone whose net worth is more than $1 million (excluding the value of their primary residence) or who has individual income in excess of $200,000 or joint income with their spouse in excess of $300,000 a year.
So, making a video of your waffle iron/curling iron combo and getting $13 million sounds pretty good, right?
Julianne McCollum, owner of Charlotte, N.C.-based Yellow Duck Marketing, cautions, “It’s not just that you have to market it, but you have to be strategic about the message and understand what problem you’re solving and for whom. So you really have to be willing to put in the time and the research. The campaigns that aren’t successful fail because people underestimated what it would take. I would also add that the quality of the graphics and the video make a big difference.”
If this sounds like a viable path to financing your next business idea, you’ll want to pick the right type of crowdfunding and the right website for you.