Crowdfunding: Definition, models, and markets

Crowdfunding is a method of externally financing business ventures. This is a newer concept that has only been defined at length in the last few years. One describes the financing of a product or project to a large amount of users, or what’s known as the "crowd". They use the internet as a platform for participation. The English word “Crowdfunding” has been directly translated into many different languages. There are four distinguishably different Crowdfunding models.

The four models for Crowdfunding

Donation Based Crowdfunding: This involves small donations typically ranging from one to two dollars. With these donations, the community finances a company without reaping any benefits from it. This model has to do primarily with non-profit and/or self-serving projects by organizations or individuals. The crowds only motivation stems from how they assess the business venture to be which is to be reflected in their self-determined donation amounts.

Reward based Crowdfunding: The focus for this financing are usually new processes, technologies, or other concepts. Implementation is only possible with the financial support of the community. Most of the time, prototypes or models are presented on the front end. Donations are usually made on a quid-pro-quo basis in that every constituent receives something like a license for a developed software or a copy of a certain physical product in return. The quality of this exchange can directly influence the donation amount. Especially in this type of Crowdfunding, there are multiple “soft goals” which are set in addition to the base financing goal, which, if achieved, the corresponding company uses to finance further endeavors. This is currently the most common form of Crowdfunding. In this way, businesses are capable of short selling to some extent without taking on too much risk. If the goal is not met, in most cases, there is almost never compensation for lost investments.

Credit based Crowdfunding: Essentially, credit or lending based Crowdfunding has to do with micro-loans. This type of Crowdfunding involves having the business model planned out exactly and stating expected earnings and repayment plans in a plausible manner. Then, the Crowdfunding platform brings the company and potential investors together.

Equity based Crowdfunding: Also known as Crowdinvesting, equity based Crowdfunding has to do with financially supporting a business venture that has already been started with the entrepreneur’s own capital. By investing, the investor purchases a share of the business with the hopes of capital gains if successful. After the reward-based variant, this is the most successful form of Crowdfunding, especially in the United States.

Market development and growth

In recent years, a variety of Crowdfunding platforms have emerged with enormous growth momentum. While the donation based model was the most popular at first, the reward and equity based models in particular have been successful in recent years. The reward model mostly finances softwares and product developments while the equity method could benefit particularly from the real estate markets.

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