Even if you ignore all the hype around crowdfunding, there can be no doubt that it is a real alternative for entrepreneurs to achieve visibility and funding today. According to a classic article on Thrinacia, there were over 600 crowdfunding platforms in existence then, estimated to add more than $89 billion to the economy at a compound growth rate of 17% from 2019 to today.

Yet as I mentor entrepreneurs around the country, crowdfunding still seems to be one of the least understood approaches to startup funding, with more myths than accredited angels and professional venture capital investors combined. The primary challenge seems to be that the crowdfunding term is used to encompass so many different concepts that everyone is confused.

In fact, perhaps the most important model, equity crowdfunding for non-accredited investors was legalized via the SEC way back in 2016, and its impact is still not fully understood. As a summary, crowdfunding today can mean any one of the following five quite different models:

1. Rewards model. Many platforms, such as IndieGoGo, allow startups to solicit funding commitments from non-professional investors in exchange for a pre-defined reward or perk, such as a T-shirt or other recognition, but no ownership in the company. The crowd gets the satisfaction of helping, with minimal risk, and no expectation of any high return.

2. Product pre-order model. With this model, a startup pre-sells their product early, at a cheaper price, in exchange for a pledge. A much-touted early success was the Pebble Watch on Kickstarter, now owned by FitBit, with advance orders exceeding $10 million. Of course, there are thousands of other companies that don’t achieve their minimum goal, requiring all contributions to be returned.

3. Donation good-cause model. This model facilitates donations to charities and creative projects, and has been around for a long time via sites such as GoFundMe. No startup ownership or financial return should be expected, but contributors can enjoy the satisfaction of furthering non-profits or causes with a passion to change the world.

4. Interest on debt model. In this model, often called micro-financing or peer-to-peer lending (P2P), people contribute with the intent to create a pool for all to borrow against. This model been popular in many countries for years, where banks loans are not available, via sites such as LendingClub and Kiva. The allure is the ability to get small loans easily, or excellent returns from the interest, but the risks are high.

5. Startup equity model. In the U.S., only accredited investors can use crowdfunding sites such as EquityNet to buy ownership in their favorite startup. In Europe, other investors can buy equity, with platforms such as Seedrs. Equity investing is very risky, but huge returns are possible if you pick the next Facebook, but failure means your entire investment is lost.

Beyond these models, the crowdfunding term is often used interchangeably or confused with crowdsourcing idea and open source development sites, such as BrightIdea, to get your ideas off the shelf and give you the wisdom of the crowds, or IdeaScale to facilitate the outsourcing of application development in an open source call to others on the Internet.

Other popular sites for startups, including StartupNation and Startups.com are not for crowdfunding, but actually are matchmaking sites between entrepreneurs and professional investors or banks, or incubators. These sites often sponsor pitch contests with small cash prizes for funding, as well as other valuable services to support entrepreneurs.

In fact, entrepreneurs can and do gain from any and all of these approaches, either by achieving some funding, or at least testing their approach and the level of public interest in their startup idea. Smart entrepreneurs often learn the most from their failures, using the feedback to pivot their solutions before squandering a large investment from friends, angels or VCs.

Concurrently, I am seeing an upswing in the number of entrepreneurs and startups, with the cost of entry at an all-time low, and the new focus on entrepreneurship in every university and every community development organization. Since there is never enough money to feed the startup beast, I don’t see crowdfunding replacing or crowding out angels or VCs in the near future.

Marty Zwilling

https://blog.startupprofessionals.com/2022/10/5-startup-funding-models-that-depend-on.html