How does crowdfunding work?

Domestic internet connectivity and project financing might appear to be topics with little common ground, yet online access enables anyone to become an amateur investor.

Your wireless router gives you access to the world of crowdfunding – a relatively modern method of digital finance, which can benefit individuals and startups alike.

It democratises product launches and gives consumers an expedited route to new or forthcoming technologies, services and inventions.

Crucially, it can even be adopted for personal gain – pet owners unable to pay for expensive veterinary treatments, or parents desperate to source finance for a child’s medical procedures.

So how do crowdfunding campaigns work? What are the advantages and drawbacks, and what do you need to know before embarking on this method of finance?

Crowded house

Crowdfunding marries together people or businesses with an idea but insufficient finance with people who (a) have finance and (b) appreciate the merits of the proposed idea.

A new parent might identify a great opportunity for a community facility or social club serving babies and toddlers, satisfying a need that isn’t currently being met.

Banks might be reluctant to lend to someone with no corporate history and a lack of five-year business plans.

Yet parents may recognise the ingenuity of this idea. Critically – and this underpins most crowdfunding campaigns – they might also want to benefit from it.

Crowdfunding is the process of allowing multiple individuals with no prior relationship or commitments to collaborate in financing a new initiative, scheme or project.

Donors can contribute as much as they wish while crowdfunding campaigns are running. They can make multiple small investments to a target figure set by the campaign’s originator.

To encourage larger investment, people seeking finance often publish tiered benefits. In the example above, a £10 contribution might earn an invitation to the initiative’s launch party.

A £100 contribution might entitle you to a year’s free membership, whereas a £1,000 contribution might yield a lifetime membership.

It’s at the discretion of the person organising the campaign to determine what incentives are offered, and it’s up to individual micro-investors to decide how much finance to inject.

Once the fundraising target is met, work can get underway – with subsequent funding rounds potentially supporting extensions, embellishments or expansion overseas.

Profit and loss

Crowdfunding campaigns are promoted online, with dedicated websites such as Crowdfunder and GoFundMe offering slightly different takes on the same general principles.

There are crowdfunding platforms specialising in medical and personal fundraising (Mightycause), the creative arts (Patreon) and startup businesses (SeedInvest Technology).

Other sites like StartEngine are geared towards helping investors maximise their returns through profits, equity, shareholdings or discounts on future goods and services.

From your home computer, you can either create a campaign for a good cause or bright idea, or invest your own money in somebody else’s bright idea.

Reputable crowdfunding platforms have checks and balances in place. For instance, if a scheme doesn’t meet its funding target, investors should be reimbursed without delay.

However, from an investor’s perspective, crowdfunding does carry some risks.

A scheme may collapse without refunding its patrons; there could be fraud involved; or the promised returns may not live up to expectations.

Your correspondent recent contributed to a crowdfunding project for a new defibrillator, which has been delayed repeatedly and now comes with unexpected restrictions on its use.

However, early access to a new product or service can be seductive, and the sense of community engendered by contributing to crowdfunding may also be rewarding.

All you need is a little disposable income or savings and an internet connection…