Crowdfunding Business Model – How Does It Work? Exposed!

The crowdfunding business model is to outsource the financing of a project to the general public. It aims to limit the influence of professional investors (how?). It starts with announcements to draw attention to projects looking for potential backers (how?).

Most crowdfunder, as they are called, are individuals or private collectives who freely decide how much they want to invest in a particular project. In return for supporting a project, backers receive some kind of project-specific reward: this can be the finished product itself, developed as part of the project (e.g. a CD or a DVD), or additional special services such as bonus material (how?).

Funding is usually an all-or-nothing proposition, meaning that a project can only come to fruition if the minimum funding goal has been met, reducing the likelihood that a project will have to be abandoned after launch.

Unlike conventional funders or banks, crowdfunder may be less interested in maximising their return than in contributing to the realisation of a project. To encourage such motives, a cap is sometimes placed on the amount crowdfunder may invest in a given project.

Under financial regulations that came into effect in the wake of the financial crisis of the last decade, this has now become a legal restriction.

For project founders, crowdfunding offers a unique opportunity to expand their investor base and thus increase their chances of obtaining favourable financing terms for their project (why?). The fact that the project is announced in advance also serves as free publicity for its inventor and can have a positive impact on the subsequent success of the product (why?).

The origins of Crowdfunding Business Model

The practice of Crowdfunding as a business model can be traced back to ancient times. Back then, funds were collected from the public to erect temples and other buildings. Today, the advent of the Internet and the creation of crowdfunding platforms have made the pattern increasingly appealing to businesses and individuals.

The British rock band Marillion made early use of Crowdfunding: under contract to a small label, the band could not afford to tour the United States in 1997 after the release of its latest album. But fans stepped in and together provided enough money in a Crowdfunding campaign on the Internet to fund the tour.

Since then, Marillion went on to make use of the business model to finance the production and marketing of their albums.

The innovators of Crowdfunding Business Model

Independent film production company Cassava Films was the first to employ Crowdfunding on the Internet to (partially) finance a film. Not having sufficient resources to complete post-production for his film, Foreign Correspondents, after the main shooting episodes, the director and founder of Cassava Films, Mark Tapio Kines, set up a website inviting interested people to participate in funding the completion of the film.

The ‘crowd’ benefited by its involvement in helping to realise a project they found interesting, while Kines’s production company did not depend on large investors to finish the job.

The production company obtained revenues from its subsequent distribution and royalties, investors received a return on profits made, and donors had the simple satisfaction of being associated with the project. Another company that successfully employed Crowdfunding is the start-up Pebble Technology, which launched a project on the Crowdfunding platform Kickstarter in 2009.

The company’s target was to raise US $100,000 to produce its Pebble watch, a digital timepiece that can communicate with smartphones via Bluetooth, allowing users to receive calls and read text messages or email directly on the watch screen. The success of the project was such that Pebble achieved the funding goal in just two hours. Overall, Pebble raised US $10 million, a hundred times its original target!

Another prominent company to use Crowdfunding is diaspora, a non-profit organisation that offers a decentralised social network not owned by any one entity, and is thus free from the influence of large corporations, advertisers or takeovers and maintains an emphasis on protecting users’ privacy.

To finance the programming of its software, diaspora launched a project on Kickstarter, which raised US $200,000 (20 times the US $10,000 target initially set). Ongoing revenue derives from donations and T-shirt sales. This is a good example of the usefulness of the Crowdfunding pattern in the case of companies offering emotionally oriented products in early development.

When and how to apply Crowdfunding

This pattern appeals intuitively to both companies and individuals. First and foremost, Crowdfunding provides access to crucial zero-interest financial resources. It also lets project initiators obtain validation for ideas early on and gauge the future success of implemented projects.

Moreover, project initiators receive valuable feedback, critique and comments from interested members of the audience, enabling them to refine their ideas without having to build prototypes or test the product in a costly pilot phase. You should use Crowdfunding if you have an appealing idea that you believe is supported by a lot of people who will be willing to put their money where their mouth is.

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