Sorting Through the Many Definitions of Crowdfunding

The term “crowdfunding” is being bandied about like crazy these days—and that’s not for nothing. According to Forbes, this year Kickstarter is set to raise more money than the National Endowment for the Arts.

The problem is that when it’s talked about there is often no differentiation between crowdfunding models. So, I’ll break it down for you here.

Donation- and Reward-based Crowdfunding
These are the models that The Crowdfundamentals concerns itself with. Though they are are used interchangeably, there are in fact distinctions. In donation-based crowdfunding, contributors are primarily motivated by philanthropy. In other words, you are willing to settle for the satisfaction derived from helping advance a worthy cause you believe in. Think of giving to a project that will supply fresh water to a rural area, for example.

In reward-based crowdfunding, there is a tangible return, and the perks are limited only by the imagination of the project creator. Filmmakers often award “producer credits” for their contribution, or a digital copy of the finished film. In this model, Kickstarter is probably best known for being the platform used by product innovators. The rewards they offer for your contribution is often the product itself. What creators are actually doing is “pre-selling” their product, so that they can raise the capital to manufacture that product. We’re now beginning to see a possible the chink in the armor of this plan. I won’t go into it here, but if you want to see crowdfunding growing pains in action, check out this recent New York Times article.

Other models include microfinance, of which Kiva is probably the best known. Contributors provide small loans to low-income people who lack access to banking services. It was initiated by economist Muhammed Yunus to address the cycle of poverty in his native Bangladesh, and he was awarded a Nobel Prize for it.

Peer-to-peer loans (P2P) allow individuals to borrow from a group of lenders, and it eliminates the need for financial institutions as well, the theory of which is that by cutting out that overhead, borrowers receive a lower rate while lenders earn higher returns than, say, a savings account. The Lending Circles is a good example of this model.

Which brings us to Equity-based crowdfunding, the model perhaps the farthest removed from above examples but very exciting indeed regarding the future of investing as we currently know it.

To backtrack, Obama signed the JOBS (Jump Star Our Business Startups) Act in April, 2012. It’s a provision that gives private company startups the ability to sell shares to individual investors like me, my mom, or your grandpop. Currently, only accredited investors can buy company stock. The implications of this are playing-field leveling, to say the least. It’s got venture capitalists worried that they are on the brink of their expiration date. And regular people who are either lucky or savvy could potentially invest in some nifty gadget that will make them millions.

But this is all still dependent on the Security Exchange Commission, which is currently tasked with figuring out the rules and regulations that protect investors but don’t cut this new source of funding at the knees. For more on that you can go to Crowdfunder, which is working to inform the public how to participate in this new way to raise equity and become an investor.

These are fascinating times, a growth spurt not unlike when the Internet first blew into our lives back in the 1990s. It’s going to be fun and interesting ride!