Crowdfunding: How and Why It Works

Crowdfunding, or crowd-based fundraising, is a relatively new phenomenon, a tool that has really taken off in the last five years. According to one definition, crowdfunding is “collective effort by people who network and pool their money together, usually via the Internet, in order to invest in and support efforts initiated by other people or organizations.” But what makes crowdfunding so interesting to me are the obscure projects that people give their own hard-earned money to, or to initiatives started by people that they don’t even know. Ever hear of the guy who raised $55,000 on Kickstarter for the purpose of making potato salad (his original goal was $10)? Or there’s the most successful Kickstarter campaign ever, which raised more than $13 million from 63,642 backers in 52 days this summer for the “Coolest Cooler” (it has a blender, waterproof speaker, and a USB charger).

There are the joke campaigns, like the potato salad, that get a lot of play in the press, and there are new gadgets like the Coolest Cooler that raise $13 million. Almost every industry can be found on crowdfunding: music, finance, fashion, and raising money for non-profits.There are Olympic athletes who use crowdfunding sites to support their expensive dreams, and movies that get their budgets entirely from fans.  Crowdfunding is anything but a joke or something to be dismissed as a fad. In 2013, crowdfunding sites raised $5.1 billion. $60,000 was raised every hour in the month of March 2014. Looking at these numbers, it’s easy to see why so many people and organizations are flocking to crowdfunding sites to fund their newest venture.

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What makes crowdfunding sites and their initiatives so successful? At its core, crowdfunding is marketing, and it uses social networks like sjd;lkgj talked about in his Ted talk to do so. It’s a way of soliciting money, except that instead of writing to or calling every person that you know, you can direct them to your site. And then it’s easy to share, so you can reach those friends of friends of friends that you don’t personally know. That’s why crowdfunding is so successful—it opens up new potential backers and “casts a wider net.” In this way, customers are the key players in crowdfunding, enabling the success of a business venture at a completely different stage of the process. Crowdfunding ‘customers’ help to create the actuality of a product or service that other customers can then consume. And unlike traditional investing, this does not involve a few players being tapped for large amounts of money; rather, it is a large amount of donors that contribute smaller amounts.

There are two basic types of crowdfunding models: rewards and equity. The rewards model is the original crowdfunding model, the one where people can “prepurchase products, buy experiences, or simply donate.” Equity crowdfunding allows the donors to become shareholders in the companies. Both of these models show what makes crowdfunding so unique: it’s changing the role of the consumer, expanding it to include investment support. Crowdfunding is changing the face of entrepreneurship and small businesses.

What drives this consumer participation in crowdfunding? Why does a person decide to give some of their hard-earned money to someone else’s desire to make potato salad, or so that a cooler can be made or that potential Olympians can keep training and reaching for their dreams? According to one study, there are a few motivators, some that contrast with each other: there’s the concept of ‘patronage,’ that people like to feel like they made the product/service/dream possible; there’s also the idea of ‘social participation’—the desire to be part of a community initiative. And finally, there’s the desire for financial payoff.

There are also three stages in crowdfunding: 1) friend-funding, in which donations pour in rapidly; 2) ‘getting the crowd’ in which news of the initiative spreads through social networks, but the fundraising slows down; and 3) the engagement moment, when a chain reaction is triggered, and the target goal is reached quickly.

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Understanding the customer’s motivations as well as the stages of crowdfunding, are important in creating a successful crowdfunding campaign. Based on the exponential growth of crowdfunding in the past five years, I think it has the potential to really change the role of the consumer in marketing, and enable a lot more entrepreneurs and start-ups.

6 comments

  1. Fantastic Post! As an aspiring entrepreneur, I have to say having crowd funding will help me potentially realize some dreams of mine that I don’t have. The concept of it being a social network to collect money is something very interesting and it is amazing to see how people will actually give out money to help people achieve their dream (Faith in Humanity restored). I am actually wondering how does kickstarter give back and calculate when does the equity holders get return if the investors are actually looking for that? It may well shake up the venture capital and private equity scene in years to come!

    1. Great point about VC. It will be interesting to see how sites like Angel List start to change the game.

  2. Great topic! I loved that you researched why consumers participate in these crowdfundings. It is always interesting to learn about the reason behind why people do what they do.
    I completely agree with you that crowdfunding is really changing the role of the consumer and it is encouraging more entrepreneurs and start-ups. I’ve personally never been on either side of crowdfunding, but I have seen that it creates some great products! Over the summer, I discovered a site called Quirky.com, which allows inventors to submit ideas and have the public help to improve it and price it. From there, the company picks the best ones and manufactures them to sell on their website, which in turn gives the inventor a part of every sale made of their invention. I find this to be very similar to the concept of crowdfunding because they are taking innovations and inputs from anyone to create a product, basically crowd sourcing innovation ideas. I feel like crowdsourcing and crowdfunding have sparked the innovation and creativity in people. People are coming up with great ideas and inventions that really help others.
    Going off the comment that George made above, I am also curious as to how kickstarter calculates the return equity holders get after there is profit from these ideas. Do you also just lose your money if the campaign never takes off or reaches the amount needed?

  3. Erin, I loved this post. I have never really heard the term ‘crowd funding,’ and I don’t know much on the topic, so I found your blog very informative and interesting. In today’s evolving digital world, crowdfunding seems like a perfect platform for businesses of all sizes to raise money, big and small. I work at the phone center for the Boston College Fund, and I personally know that asking for donations can be difficult. I think though, that crowdfunding could be an easier way to collect and raise funds and encourage more people to become involved in businesses because its less personal and allow those to give the amount that they feel most comfortable with.

  4. Your post did a great job of highlighting the recent boom in crowdfunding and the successes that are inherently there with its model. However, for every crowdfunding success there are countless failures. Kickstarter and other platforms have failsafes in place for the campaigns that happen to not take off, but that may not be enough sometimes. Some of the biggest offenders are campaigns that hit their target but then completely fail to deliver on what they promised.
    Crowdfunding is a new field that has very little regulation. The red flag that is always raised with regulation is that it’ll stifle innovation and narrow the realm of possibility, but at the same time those who give their money need protections as well. Regulation will eventually find its way into crowdfunding, and it’ll be fascinating to see what the government will do and how this fledgling industry will react.

  5. Nice post. Its been really interesting to see crowdfunding evolve as a phenomenon over the past few years as I’ve been teaching this course.

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