How Crowdfunding Works


Co-anchor Lara Spencer talks to Zack "Danger" Brown on "Good Morning America" in July 2014. Brown launched a Kickstarter campaign to make potato salad and raised $55,000 from his original $10 goal.
Co-anchor Lara Spencer talks to Zack "Danger" Brown on "Good Morning America" in July 2014. Brown launched a Kickstarter campaign to make potato salad and raised $55,000 from his original $10 goal.
Fred Lee/ABC via Getty Images

Zack "Danger" Brown wanted to make some potato salad. Not as a business — just to try his hand at making the popular picnic dish. He figured he needed $10 to whip up a batch. So Brown launched a Kickstarter campaign on July 3, 2014, to fund his potato salad production (yes, really). By the end of his campaign 30 days later, he'd received an amazing $55,492 from 6,911 backers [source: Kickstarter]. Brown's quirky crowdfunding campaign was a resounding success.

Crowdfunding is a modern way to raise money. People use the Internet to advertise a product or project they'd like to create, or a debt that needs repaying and ask donors around the globe for money to achieve their goals. The crowdfunding websites charge campaigns a fee, generally 3 to 10 percent of the funds collected in a fully funded campaign [source: CrowdfundingBlog].

Since the fundraisers are ostensibly short on dough, donors are rewarded by nonmonetary or inexpensive means. Brown, for example, promised $1 donors that he'd thank them online, plus say their name out loud while he concocted his potato salad. Donors who threw in $2 were additionally promised a photo of him making the potato salad [source: Kickstarter]. But sometimes donors are promised bigger items, like a CD of the album donors are helping the band to make, or for a really big contribution, perhaps a private meeting or dinner with the campaign founder.

Not all projects are accepted on crowdfunding sites; each site has rules for which types of projects it will accept. But sometimes the guidelines are cryptic. And if projects are turned down, you're not always told why [source: Null].

Don't think crowdfunding is an anomaly. In 2014, the practice grew 167 percent from 2013, with $16.2 billion raised versus $6.1 billion in 2013. Experts expect the industry to double again in 2015, with some $34.4 billion being raised. North America leads the world in the practice, although Asia is quickly becoming a major crowdfunding region [source: Crowdsourcing].

While crowdfunding sounds like a great idea, and can be a relatively seamless way to finance a worthwhile project, most fail to garner enough support. And depending on which platform you use, you may not get to keep the money raised unless you met your entire goal. And from the donors' point of view, there is always the possibility that even if the project is fully funded, it doesn't see the light of day.

The History of Crowdfunding

In 2012, Pebble Time raised more than $10 million on Kickstarter to fund its smart watch. In 2015, it doubled that to more than $20 million for the second version of the watch, the biggest amount ever raised on Kickstarter.
In 2012, Pebble Time raised more than $10 million on Kickstarter to fund its smart watch. In 2015, it doubled that to more than $20 million for the second version of the watch, the biggest amount ever raised on Kickstarter.
Alissa Hankinson /Getty Images

You may think crowdfunding is a newfangled thing. The name is, but the practice has been around for hundreds of years. In the 1700s, author Jonathan Swift created the Irish Loan Fund, which lent small amounts of money to rural, low-income families for short periods. A century later, more than 300 similar programs were sprinkled throughout Ireland; at one point, 20 percent of all Irish households were receiving these loans [source: Clark].

Fast-forward to Bangladesh, 1976. Dr. Mohammad Yunus and his graduate students joined forces on a research project: lend small amounts of money to poor people so they could create businesses and become self-employed. The group first lent $27 to 42 women. Within five years, the program had more than 30,000 members. In 1983, it formally became Grameen Bank. Yunus and Grameen Bank won the Nobel Peace Prize in 2006 for their work in economic and social development [source: Clark].

The first Internet "crowdfunding" success happened in 1997 when a British rock band funded its reunion tour by soliciting online donations from fans [source: Fundable]. In 2003, musician and composer Brian Camelio created ArtistShare, the first official, dedicated crowdfunding platform. ArtistShare connected artists and fans so the two groups could join forces in the creative process while also funding new artistic works. Projects funded through ArtistShare have received nine Grammy awards and 18 nominations [source: ArtistShare].

Next came Kiva.org, the first microlending website. People lent small amounts of money to entrepreneurs in developing countries. The first peer-to-peer lending site in a developed country (the U.S.) debuted in 2006 — Prosper.com. Applicants submit a request for funds, along with their story, a photo and their credit risk. Interest rates for loans are generally less than those offered by financial institutions [source: Clark].

Today's well-known crowdfunding site, Kickstarter, was launched in 2009 to help people fund a project or product, such as a CD, documentary, smart watch or, yes, a batch of potato salad. Like ArtistShare, the funds raised aren't loans to be repaid. Rather, donors receive small rewards based on the amount they donate [source: Clark].

With crowdfunding increasingly important to America's small businesses, President Barack Obama in 2012 signed into law the Jumpstart Our Business Startups (JOBS) Act. Aka the "crowdfunding bill," it legalized equity crowdfunding, among other provisions [source: Fundable]. Crowdfunding was officially part of the American economic scene.

There have been enormous successes. In mid-2015, the most profitable Kickstarter campaign, Pebble Time, raised more than $20 million to produce a smart watch [source: Zipkin]. Pebble Time could probably have raised their cash from a more traditional source, but that wouldn't have gotten the marketing buzz generated by the super-successful campaign. Plus, it gave them a pipeline to their most loyal customers — the folks who helped fund their earlier Kickstarter campaign for the first version of the watch [source: Hern].

But before you get started on your own campaign, know this: Most crowdfunding projects fail.

How Do I Create a Campaign?

Carlos Wong poses with his staff and a cat during an event to promote his Kickstarter campaign for Catfe in Los Angeles. The cafe would allow patrons to interact with cats up for adoption. Wong's goal was $350,000 but he only raised $9,000.
Carlos Wong poses with his staff and a cat during an event to promote his Kickstarter campaign for Catfe in Los Angeles. The cafe would allow patrons to interact with cats up for adoption. Wong's goal was $350,000 but he only raised $9,000.
MARK RALSTON/AFP/Getty Images

In mid-2015, Kickstarter reported its projects have a 37.3 percent success rate; 14 percent of the projects launched never raised one cent. Most of the successfully funded projects raised less than $10,000. So the odds are against you.

That's not to say you shouldn't launch a campaign, of course. But it's smart to know what you're up against. Some of the top groups include Crowdfunder, Crowdrise, IndieGoGo, Kickstarter and RocketHub. These groups aren't the same, though. Crowdfunder is used to raise investment capital, so funders become shareholders who may get a financial return. Crowdrise is for seeking donations to charities and causes [source: Barnett].

Your campaign's success will depend in large part on being able to excite and inspire potential investors. A quality video clip is important. Projects with videos are a whopping two to three times more successful than those relying solely on the printed word. Invest in a professional videographer, and make sure you not only explain your project but also give the personal story behind it. People become more passionate about a project when they learn about its creator. The finished videos should be no longer than three minutes [sources: Andrus, Kuo].

To address concerns about products that may never be delivered, Kickstarter for one prohibits product renderings and simulations in your videos, although CAD designs are OK. You must also talk about the risks and challenges associated with completing your project on your campaign page.

Next, you'll need to start building a support network. People would rather get behind what they view as a popular project instead of being the first one to click "Back This Project." Tap your family and friends, and friends of friends, until you have 20 to 50 supporters ready to jump in the minute your campaign goes live [sources: Kuo, Barbara].

Once your project is up, communicate with your supporters often to keep them in the loop about what you're doing and how things are going. If you're operating under a reward model, pump up those as well. You don't want to simply ask for money and disappear. Keep supporters engaged and excited. If you reach your goal, thank your supporters, and promptly send out their rewards. Then get to work on that project!

Crowdfunding Do's and Don'ts

As with any business venture, there are a lot of moves critical to your success, plus ones that can easily torpedo a solid idea. Here are some of crowdfunding's major do's and don'ts, gleaned from innumerable campaigns.

DO

  • Set your launch date several months out. During this time, garner support for your project, reach out to journalists and build a presence on social media. If you launch without doing so, there will be no immediate buzz about your project, and you'll never have enough time to create one before your campaign ends.
  • Factor shipping costs into your planned rewards. Many people running reward-based campaigns are shocked by the postal fees when it comes time to send out their promised rewards to supporters. HSW writer and podcaster Christian Sager, who has three successful Kickstarter campaigns for comics under his belt, says he knows of campaigns completed years ago that still have never sent out their rewards because they underestimated shipping costs. Those donors are certainly not likely to support another campaign from you, or possibly anyone else.
  • Keep your campaign short. Thirty days or less is ideal [source: Berkeley Sourcing Group].
  • Keep your supporters updated. Tell them if you've started writing that novel, tested your prototype or scheduled Fido's surgery. If you update every few days, you're statistically likely to raise 100 percent more money than campaigns that don't [source: Lee].
  • Time your campaign to finish near the end of the month. Many people have paychecks coming in then, says Sager. If you've got money in your pocket, you're more comfortable investing.

DON'T

  • Think crowdfunding is as simple as slapping a video online. Sager estimates he spent nearly 40 hours per week during each of his three campaign runs, mostly on promotion and marketing, and communicating with donors and potential donors. If the funds aren't coming in at the rate you need to succeed you may have to think of new strategies or videos on the fly.
  • Freak out if it looks like you won't reach your goal. Typically the bulk of your funds roll in during the first and last week of your campaign [source: Kuo].
  • Think you can't go back to the well. Lots of people crowdfund successfully numerous times over. According to Kickstarter, those who ran one successful campaign and tried a second have an impressive 73 percent success rate. By the time someone has four successful campaigns under his belt, his chance for meeting his goal on a fifth project is 91 percent [source: Gallagher and Salfen].
  • Relax if you hit your goal. You've got to send out your supporters' rewards, if you've run a reward-based campaign, thank everyone and complete your project.

Author's Note: How Crowdfunding Works

I haven't tried crowdfunding yet. But my brother suggested we start a campaign to pay for pricey therapy that could help our daughter, whose knee was ruined from a pain pump that should never have been used on it. (Suing is not an option; the pump manufacturer went out of business from previous lawsuits, and the statute of limitations ran out on going after the surgeon.) We'll see!

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Sources

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