Crowdfunding is changing the way entrepreneurs get the capital they need to put their business ideas into action.

What is it?

It’s simply a method of raising capital through a group of people and individual investors (“the crowd”). Crowdfunding takes advantage of the collective efforts of a large pool of individuals, leveraging their networks for greater reach and exposure.

Crowdfunding turns the traditional venture capital model, where early-stage companies receive investments from one or a few select institutional investors, on its head. It allows you to secure different levels of investment from a much more diverse pool of investors.

Crowdfunding also offers you a single location to share your investment pitch, which eliminates the need to approach potential investors individually. You get to showcase your opportunity from a single platform, and a large group of interested parties can review it and decide whether to invest.

The 4 Different Types of Crowdfunding

The concept of crowdfunding encompasses several different investment types:

1. Reward

Reward-based crowdfunding gives investors different levels of support to choose from. Investors receive rewards (which typically aren’t monetary) based on their contribution amount. Rewards could be t-shirts, discounts, executive producer credits, or often the item being produced with the funding.

2. Donation

With donation crowdfunding, backers make contributions to certain projects or social causes. Besides a potential tax write-off, they don’t receive anything in return other than the satisfaction of supporting something they believe in.

Donation crowdfunding works well for charities, political campaigns, and social causes that aren’t actively seeking to make a profit.

3. Debt

Debt, or peer-to-peer lending, crowdfunding is used for investments. People borrow money from a group of people (“the crowd”) instead of an institution. This allows for quick and easy business loans. In exchange, companies make interest payments directly to investors instead of a bank or credit union.

4. Equity

Equity crowdfunding is the most sophisticated application of the funding model, and the subject of this report. In this strategy, investors receive equity (partial ownership interests) in a company in exchange for their financial contributions.

Entrepreneurs get access to much-needed capital without having to issue stocks in costly, time-consuming ways (like an IPO, for instance). Investors get dividends, appreciation, and a healthy ROI.

The History of Crowdfunding

Crowdfunding might seem like a modern phenomenon, but it actually dates back hundreds of years. In the 1700s, Jonathan Swift started a fund to give loans to low-income families in Ireland.

This concept evolved over time; today, many people also call it “micro-financing.” Modern technology took this funding approach to another level. In 2003, ArtistShare became the first online platform dedicated to connecting creative artists and fans via a crowdfunding model.

Since then, countless other platforms have emerged (including some big names like Kickstarter). The crowdfunding industry has exploded thanks to creative new applications in the investment world like peer-to-peer lending and equity crowdfunding.

Successful Crowdfunding Efforts

There have been numerous success stories from various types of crowdfunding efforts over the years.

Here is just a snapshot of a few:

Oculus Rift

Oculus rift, the virtual reality head-mount display used for video gaming, raised over $2.5 million via donation-based crowdfunding before the first Oculus Rift headsets shipped in March 2013.

Veronica Mars movie

Seven years after it was taken off the air, fans of the Veronica Mars television series raised over $5.7 million (the funding goal was only $2 million) to fund a studio -backed film adaptation.

5 CUPS and Some Sugar

This tea company raised over 300,000 euros on the German crowdfunding platform Companisto in 2013. Less than two years later, the company decided to buy back the equity crowdfunded shares for 436,000 euros. The investors accepted, earning a 45 percent return in the process.