Will the Real Crowd Funding Model Please Stand Up?

The new hot topic for entrepreneurs these days is crowd funding, which is anticipated to at least supplement, if not replace, the slow and mysterious process of current Angel and venture capital investors. The problem is that crowd funding means something different to everyone, and even I have been confused by the different ways the term gets used.

So I have set out here to outline and offer some practical advice on the many different models currently used with the term “crowd funding” and “crowd sourcing.” The newest model was passed into law recently via the JOBS Act, and won’t even be available until the end of this year or maybe mid-2013 in the USA, while waiting for the rules to be finalized:

• Startup equity crowd funding. This new model will allow large numbers of “regular” people to invest small amounts each online to fund early startups. This is not a get-rich-quick vehicle for consumers. As a current Angel investor, I can attest that any investments in startups are more risky than the commodity markets, and you shouldn’t expect to see any return for five years. Proceed at your own peril.

• Good-cause crowd funding. This model is a good thing, and has been around for years. Example sites include StartSomeGood and the Facebook Cause page. People can invest (donate) money to a project which has good moral/ethical value. No financial return should be anticipated, but contributors should enjoy the feeling of doing good.

• Pre-order crowd funding. Here people make online pledges with their credit cards during a campaign, to pre-buy the product for later delivery, if it is ever built. Kickstarter is the big player in this space. It has had some notable successes for entrepreneurs (over $1M in funding), as well as non-starters. There is no concept of ROI other than product.

• Rewards-based crowd funding. This is a variation on the two previous ones, where investors get the satisfaction of helping, and immediately get a pre-determined reward or perk of value, such as a t-shirt, or other recognition, but no equity or finished product. A good example site, and one of the earliest in this category, is IndieGoGo.

• Debt-based crowd funding. In this model, sometimes called micro-financing or peer-to-peer (P2P) lending, you borrow money from a number of people online and pay them back after the project is finished. This has been popular in many countries for years via sites like LendingClub and Kiva. The allure is fat returns, but they come with a huge risk.

• Ideas crowd sourcing. Technically, this model is not involved with funding at all, but “crowd sourcing” and “crowd funding” are often used interchangeably. Sites like GeniusCrowd get your ideas off the shelf, and give you the wisdom of the crowds. Of course, this might also lead to investors, partners, and licensing opportunities.

• Software crowd sourcing. This is basically the Open Source concept, where sites like IdeaScale facilitate the outsourcing of application development to the Internet community in the form of an open call. Sometimes contributors may get compensated later, but usually the rewards are just kudos and intellectual satisfaction.

Don’t confuse any of the models with other popular funding sites for startups, like FundingUniverse and GoBigNetwork. These are primarily matchmaking sites between entrepreneurs and professional investors or banks. Often they do sponsor pitch contests with small cash prizes for funding, as well as other valuable services to support entrepreneurs.