Crowd + Funding = Crowdfunding
Crowdfunding has come a long way since it first gained popularity in the arts and music communities when, in 1997, the rock group Marillion raised $60,000 in online donations to fund a tour around the US.
By 2010, the crowdfunding model had reached maturity with sites like Kiva, Kickstarter, IndieGoGo, GoFundMe, MicroVentures, and YouCaring. Many other sites have sprung up since then, catering for a wide range of audiences. Enormous amounts of money have now been raised through crowdfunding such as the recently successful campaign by Oculus Rift - (the Megamind VR firm that was acquired by Facebook) whose original funding target was $250K but ended up closing the campaign with a whopping $2.4 million in investment commitments.
Crowdfunding’s biggest achievement has been the democratization of investment. So, instead of an entrepreneur having to raise a large amount of money from a small group of high-net-worth individuals (as was the case in the past), she can now raise small amounts of funding from a much bigger “pool” of individuals, like you or I, who can put in as little as $20. This makes the process of crowdfunding very appealing - both for the investor and for the entrepreneur.
Despite this popularity, there is still some confusion around the term “reward” and it has seeped into all aspects of crowdfunding in one form or another.
In the early days of crowdfunding, the only incentive for attracting money was to offer some form of reward. In other words, giving away equity was unheard of back then. And the basic principle was: the more money you can give, the higher the level of reward. Today, however, there are several ways of leveraging rewards as part of your crowdfunding campaign. For example, you can:
run a “rewards only” campaign (no equity or loan involved);
“top up” an equity or loan campaign by offering an additional (optional) reward.
However, even in the case where no visible reward is offered, ”there’s still a kind of reward involved, as you’ll soon see.
So let’s clarify.
- What exactly is a reward?
- How are rewards used?
- When do they apply?
- And what’s the fine print, if any?
This article aims to quickly clarify any potential confusion when we talk about rewards and crowdfunding so that you can make the best investment or fundraising decision.
First - The 4 types of crowdfunding
Rewards only crowdfunding campaigns
It makes sense to start with this type of campaign since this is where crowdfunding really took hold and is often the source of confusion So let’s clarify this from the start.
Shortly after Carillon’s successful campaign, others followed suit, such as Artistshare (2000) and Sellaband (2006) where musicians offered a number of rewards to fund their artistic projects and/record labels. Since then, IndieGoGo and Kickstarter have emerged as the predominant platforms for rewards-only crowdfunding.
With rewards-only crowdfunding, individuals donate money in return for a non-financial reward such as a product or service, and the donor does not receive any equity (shares) in return. Rewards generally tend to be in proportion to the amount of funding received. Certain types of products and services for general public consumption lend themselves well to rewards-based campaigns. For example, food and beverage, sports and outdoor apparel, as well as many technology products can be great incentives for crowdfunding, especially if a company wants to validate market demand for its products or services. Rewards can also include classes, personal tuition or coaching, exclusive invitations to events, social media exposure, or a chance to network with the company’s founders. However, a company making electricity power generators or public swimming pool cleaners might want to think twice about the types of rewards that might appeal to the general public.
The key thing to remember here is that the main incentive for giving money is the reward itself - and nothing else.
What do charities, food banks and relief foundations have in common? Donations. Individuals donate money to a specific cause, charity, or event without expecting any type of reward in return. GoFundMe, FirstGiving, and GiveForward are some popular donation-based crowdfunding platforms aimed at raising funds for charitable causes.
Here’s an example of a donation-based crowdfunding campaign for supporting the education of rural kids in southern India.
As as we hinted earlier, although there is no formal reward in donation-based crowdfunding, there is always the strong sense of personal or community satisfaction gained from having made the donation. This sense of satisfaction in itself can be viewed as a reward.
Also known as peer-to-peer (P2P) lending platforms, debt-based crowdfunding platforms can offer companies seeking a loan a compelling and competitive alternative to traditional banks. In the past, a company seeking a loan would go to one source - a bank. However, today that same loan requirement can be sourced from a wider pool of investors who might also be more closely aligned with your endeavor. In debt-based crowdfunding, individuals lend money to companies or other individuals, in return for repayment of the loan plus interest.
In debt-based crowdfunding, individuals lend money to companies or other individuals in return for repayment of the loan plus interest. Terms of the loan usually still come with the usual screening and credit checks of “traditional” banks. However, since the internet removes many costs such as administration costs, the time taken to reach a lending decision is normally much faster and interest rates tend to be lower when compared to traditional banks. Also, loan terms are quite flexible, thus making repayment easy. Strictly speaking, there are generally no rewards associated with debt-based crowdfunding. However, some companies seeking a loan have been known to offer additional incentives, such as a reward in the form of product or service that the company makes, although this is not as common as in equity-based crowdfunding.
Equity-based crowdfunding (Securities-based)
In this crowdfunding model, a business raises funds in return for shares in the business. Think of equity crowdfunding as a mini IPO (initial public offering), except that the stock sales don't happen in a stock exchange. In equity-based crowdfunding, investors become shareholders in the business. It’s also not uncommon nowadays for a business seeking funding to also offer additional rewards which are generally in proportion to the amount of money pledged. Just remember though that the main driver of equity-based crowdfunding is the shares on offer and that the reward is often considered a bonus or incentive to speed up the closure of the funding round.
Back to rewards-based crowdfunding. How does it work?
Now that we’ve cleared up the confusion around how rewards play a part in different types of crowdfunding, let go back to rewards-based (i.e. rewards-only) crowdfunding and see how it works.
As we said earlier, rewards-based crowdfunding lends itself well to certain campaigns as long as the rewards are attractive enough to incentivize the donors to put money into the project. So, if you’re an entrepreneur thinking of listing on a platform like Republic, it would be wise to do some initial testing to see whether not only the rewards will work, but also whether the rewards are sufficiently tiered to attract different levels of funding commitment from investors.
Assuming that’s already in place, here’s how rewards-based crowdfunding then works:
An entrepreneur lists a project to be funded on a crowdfunding platform with a fixed deadline.
Social media interactions and promotional videos are created to spread the word and garner more attention around the campaign.
Interested donors contribute to the project while attracting their own social media connections, drawing in a wider net of donors.
The backers are rewarded based on their donations. Here are four popular categories of rewards:
If the crowdfunding seeker is a musician, he/she could enable the early purchase of music albums. Several video game creators also grant special early game access to the contributors.
For a good example of how this works, here’s how the Seafloor Cinema is funding their music voyage by offering backers a digital download of their latest album!
The product or service Itself
This can be any product with consumer appeal and of course, the more innovative and unique, the higher the chance the project has of succeeding in attracting backers. For example, how about a gesture-controlled mouse or a solar-powered bluetooth speaker?
A top-up reward in an equity crowdfunding campaign
Many equity crowdfunding campaigns also offer a reward in addition to the equity. As we said earlier, the equity on offer is always the key incentive in such a campaign, not the reward. However, offering an additional reward can come in very useful for many reasons - customer validation, saying thank you, and even stimulating the campaign itself. This additional “stimulus” can be a very powerful tactic sometimes, serving to get investors across the line in order to reach a funding goal (i.e. “if you’re on the fence about investing, then we’ll throw in an additional reward if you decide to invest”). Take a look at Fig.co’s explainer video for example to see how they encourage additional rewards on their equity crowdfunding website.
Sometimes, entrepreneurs give their potential investors exclusive access to the company or invite them to participate in certain activities, events, or even trips. Office visits or a special prototype demo unveiling are memorable experiences that backers would undoubtedly relish.
GRITBXNG, an innovative health and fitness company which combines fitness with a new way of meeting people, is a great example of a company offering different experience “bundles” alongside equity during its crowdfunding campaign. Depending on the amount invested, a potential investor could expect to be rewarded with some very generous experiences ranging from exclusive “investor-only” parties with an open bar, investor-only private classes, all the way up to a ski weekend, and even a 7-night stay for up to 14 people.
Ideally, within a few months of successful funding, the backers receive their rewards.
Pros vs cons of rewards-based crowdfunding:
It’s a great way for young companies to validate their products - people signing up for your crowdfunding campaign can help establish a strong customer base and pave the way for upselling and market traction.
On some crowdfunding platforms such as Republic, crowdfunding campaigns are goal-oriented, which means that failing to achieve the set goal can translate to forfeiting any funds raised.
There's no equity dilution as project owners only exchange rewards. No shares are issued.
Pitching your novel ideas online reveals your product to your competitors who will be watching closely.
- Does Republic offer rewards-only crowdfunding?
No. All the campaigns on Republic are securities-based (investors receive shares in return for their investment) and we do not permit “rewards-only” campaigns.
- How long should the crowdfunding campaign last for?
Typically, a rewards-based crowdfunding campaign lasts for a month. However, in some cases, the period is slightly shorter or even longer. Usually, the minimum and maximum durations would be pre-determined by the chosen crowdfunding platform.
- How to decide what to “reward” backers?
If you’re an entrepreneur considering running a rewards-based crowdfunding campaign, as a general rule of thumb, ensure that the rewards are tangible, generous, and you’ve got enough in supply to go around. Additionally, build in a sense of urgency, exclusivity, or uniqueness into the rewards, e.g., a limited edition of a product that the general public would not have access to once it goes on sale. Also, make sure you do your homework on your target demographics - and confirm that it has broad appeal to the people you are targeting in your rewards-based crowdfunding campaign.
- How do taxes come into the picture?
Remember that rewards-based crowdfunding carries tax implications since any reward will be considered as a “taxable benefit.” It’s always wise to consult your financial advisor in your jurisdiction to assess the level of tax payable on such a reward and then communicate it clearly in your crowdfunding campaign. Every crowdfunding platform will also have their own fine print with regard to tax issues. The key point here is ensuring that your donors know that this is a taxable benefit. That way, at least from your side, you’ve carried out your duty.
Crowdfunding is an extraordinarily innovative and time-efficient method to raise funds.
Primarily, there are four types of crowdfunding: Donation, Debt, Equity and Rewards.
Rewards-based crowdfunding is all about providing contributors with some level of (optional) reward. The business rewards the donor with a product or service in return for money into the business, and the level of reward is usually tiered, in line with the level of funding pledged. In rewards-only crowdfunding, no shares are issued and there’s no loan taking place. In campaigns where rewards are optional, the key incentive for the donor is either stock or interest on a loan, and any reward is considered a bonus.
The pros of rewards-based crowdfunding include ease of raising funds and increased customer loyalty opportunities. The cons include chances of idea theft as well as a risk of losing raised funds if unable to meet the funding targets.
How to run a successful rewards-only crowdfunding campaign as a founder?
We’d love you to consider joining us at Republic, but, as outlined earlier in our FAQ, all our crowdfunding campaigns are securities based (shares are issued) and we do not permit rewards-only campaigns on our platform. However, we do allow “bonus perks” perks as part of the campaign. If you’re considering a rewards-only campaign, then you should therefore consider one of the other “rewards-only” platforms.
And before you go, here’s our general advice for rewards-only campaigns:
Tailor your pitch to present your product or service as a unique solution to actual pain points that your customers are facing.
Brainstorm both the type and level of reward that will incentivize your backers. Make them feel special and if you impress them well enough, you might make many repeat sales in the future.
Create a compelling video that summarizes all the critical features of your project. Also, leverage your social media networks to ensure maximum participation in your rewards-only crowdfunding campaign.
Make sure you understand the terms of your rewards-based crowdfunding campaign, such as timelines and funding targets.
All in all, rewards-based crowdfunding is a great way to fund your business without giving equity away. And if you’re an investor, there’s no better way to help an innovative new company grow rapidly than to share in its success by being a user of one of its products.
Still interested in equity crowdfunding? Why not give Republic a shot?
If you’re either an entrepreneur seeking investment and prepared to issue shares or an investor looking to invest, then Republic is a renowned crowdfunding platform with an excellent track record of over 90% success since 2016.
Just recently, over five startups on Republic hit the million-dollar club. And we’re continuously upgrading our user experience to ensure the onboarding process is super easy. As a result, you can now tweak your campaigns to ensure the best results.
If you’re an investor, simply follow these steps:
Create an investment account (Republic allows you to invest as little as $10, and you can even use a credit card).
Ensure you carry out your due diligence before backing companies. Is the company or idea you’re considering investing in really something you’re something that you’re really passionate about?
Go ahead and invest in your favorite companies or ideas.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.