Crowd Funding: Meaning, Types, Pros & Cons

Are you planning to start a venture of your own? One of the first things on the checklist to start a small business is capital. Earlier, this requirement was fulfilled through organic networks (family, friends, colleagues, etc.) or banks and other lending institutions. Though the trust factor was a significant advantage here, the capital sources often got limited to a familiar circle. 

The scenario started changing in 2010. Even though traces of crowdfunding can be seen in recent history, the gates were open for startups and small businesses with the advent of crowdfunding platforms in India in the early 2010s. What is crowdfunding for business startups? How to crowdfund my business? Let’s understand.

What is crowdfunding in business?

Crowdfunding for business is the act of gathering small amounts of capital from many individuals to fund a new business venture. This is often done through social media and crowdfunding websites that connect investors with entrepreneurs. Crowdfunding bypasses traditional funding channels, allowing direct connections with potential backers through online platforms. This method also boosts entrepreneurship by expanding the investor pool and opening their business to a larger group of potential investors, thus eliminating the need to rely solely on large sums from a few sources. 

You can set up a crowdfunding campaign for the following purposes:

• Business ventures, especially startups
• Individuals and NGOs for emergencies like natural disasters, high medical expenses, and personal tragedies
• Creative individuals, such as artists, writers, filmmakers, and musicians, to fund their creative projects

What are the types of crowdfunding?

• Donation-based:

If you have an idea that benefits everyone, people might donate without expecting anything in return. This is donation-based crowdfunding. It is mainly for charitable purposes and social causes by many NGOs and philanthropic organizations for various causes such as medical assistance, childcare, education, and poverty alleviation.

• Reward-based:

In reward-based crowdfunding, funds are contributed in exchange for a reward. It is also known as seed funding. As a recipient, you don’t need to return the money but compensate contributors with goods or services. It operates on a reward exchange basis, offering a win-win situation for the parties involved. Additionally, it serves as a marketing tool since companies can sell their products and services to their funders.

• Debt-based:

In debt-based crowdfunding, the borrowed funds must be returned to the lenders with interest. Also known as peer-to-peer lending, debt-based crowdfunding is often better than bank loans to effectively raise capital for new or ongoing businesses. However, it is often suggested to opt for this option if you have a steady cash flow and are confident in your ability to repay the amount, as it involves many lenders. 

• Litigation-based:

Litigation crowdfunding usually happens confidentially. In this setup, funders assist a litigant in raising money to fight their case. Plaintiffs get funds from various sources, including peers and other contacts, as donations or rewards. However, in this type of crowdfunding, funders receive their rewards only if the plaintiff wins the case. These rewards are often a share of the monetary settlement as a pre-decided percentage of the recovered amount. Rewards can also be non-monetary, like recognition or contributing to a cause. 

How do I choose the right type of crowdfunding for a business startup?

With the multiple options in the market, it gets confusing to answer one question- how to get crowdfunding for my business? And what type to opt for? The answer depends on factors like the nature of your business, your business goals, and your ability to fulfill the compensation required for each method of crowdfunding. Here are some similar factors to consider-

• Nature of your business or project

Reward-based crowdfunding might be ideal if you're launching a new product or service. Donation-based crowdfunding is a good choice for businesses with a strong social or community mission. If you plan to scale your business with traction and are willing to give up equity, consider equity-based crowdfunding.

• Financial needs and objectives

Different crowdfunding methods generate varying capital amounts. For larger sums, equity or debt-based crowdfunding is suitable. On the flip side, if the requirement is smaller, consider opting for reward or donation-based crowdfunding.

• Market validation

If you are launching a business, getting an idea of how the market will react to your product or service is a bonus. In such a scenario, reward-based crowdfunding is beneficial for raising funds and getting valuable customer feedback and validation.

• Ability to fulfill obligations

Ask yourself if you can fulfill the obligation of each crowdfunding method. If you can deliver the promised rewards in time, opt for reward-based crowdfunding. If you are confident in repaying a loan for debt-based crowdfunding, opt for it instead. 

• Legal and regulatory considerations

Equity and debt-based crowdfunding involve more complex legal and regulatory requirements compared to reward or donation-based crowdfunding. Ensure you understand these obligations.

Now that you have clarity on the choice of method let’s read further to learn how to crowdfund a business idea.

How to get crowdfunding for my business?

Crowdfunding for startups is a popular way to raise funds. Here are some tips for starting a crowdfunding campaign.

1. Research thoroughly before launching your campaign. With many platforms available, it is imperative you carefully choose the one that best suits your startup.
2. Create an attractive video that summarizes your startup idea. This is your primary way of presenting your business to the public. Make sure the video captures attention and excites the potential investors about your product or service.
3. Set a realistic fundraising goal. If your goal is too high, people may hesitate to donate. Conversely, a goal that's too low may not motivate people enough to contribute.
4. Offer rewards to encourage contributions. People are more likely to support your campaign if they receive something in return. Ensure the rewards are appealing and desirable.
5. Promote your campaign as widely as possible. Use social media, email marketing, and other digital channels to spread the word about your crowdfunding effort.

Crowdfunding as a tool has helped finance numerous businesses. With the introduction of online platforms like Ketto, Indiegogo, or Kickstarter, the finance pool has increased over the years. However, along with the growth in this market, the number of finance options from banks, financial institutions, and government initiatives has also increased. So, how is crowdfunding better than the rest?

Pros and Cons of Crowdfunding in India for Business

Crowdfunding (India) for business offers a quick way to raise finance without upfront fees. It has thus become a popular way to raise money for various projects and businesses. While it's not the only way to finance a startup, it can be a great option for many business owners for several reasons.

First, crowdfunding helps gauge interest in your product or service. If people are willing to contribute money, it shows a favourable market for what you’re selling. Additionally, crowdfunding generates buzz and excitement around your business launch. Involving people early on creates a community of supporters who will promote your product or service. Finally, crowdfunding provides access to capital that might be hard to obtain otherwise, especially for unconventional business ideas. Whether you need seed money to start your business or funds to expand, crowdfunding can offer the necessary resources. Plus, in most scenarios, your investors often become your most loyal customers. 

However, there are downsides. Running a successful campaign can be time-consuming, and there’s no guarantee you’ll reach your funding goal. If the campaign turns out to be unsuccessful, your brand reputation might be affected. Moreover, campaigns requiring you to mention your business idea or innovation in detail can also lead to intellectual property theft. 

If you're willing to put in the work, though, you can handle the drawbacks, and crowdfunding can effectively finance your startup. With the right approach, you can tap into a powerful funding source and build momentum for your business.

Conclusion

Crowdfunding is a transformative fundraising method for today’s entrepreneurs. It offers a unique way to access capital, validate ideas, and engage with a supportive community. Its versatility across sectors and business types makes it a valuable tool for embracing innovation and direct audience connection. So, if you’ve decided crowdfunding is right for your startup, research various platforms to find the best fit. Prepare your pitch and content, set a fundraising goal, and plan your campaign launch. Potential donors and investors will be well within reach. Moreover, as the regulations evolve and more entrepreneurs leverage crowdfunding, it will increasingly shape the future of business financing in India will be increasingly shaped.

FAQs

Q1. What mistakes should I avoid when crowdfunding my business?

Ans. When you are crowdfunding for business, avoid these common mistakes:

• Failing to prepare your campaign, including photos, videos, and a timeline.
• Setting an unrealistic funding goal.
• Not being transparent about the use of donors' money.
• Being impersonal, especially in your video.
• Launching your campaign too early.

Q2. Can Crowdfunding be repaid by the business? 

Ans. It depends on the crowdfunding model. Donation-based crowdfunding requires no repayment. However, reward or lending-based models usually involve some form of repayment. The exact terms vary, but financial compensation is often needed.

Q3. Is crowdfunding for business taxable in India?

Ans. According to the Income Tax Act, NGOs and nonprofits raising funds from crowdfunding platforms are fully tax-exempt. However, individuals receiving contributions from crowdfunding platforms in India for any other purpose must pay tax.