Crowdfunding is a new phenomenon that aggregates small amounts of money from many people to do something…and that something can range from funding a T-shirt design to helping a charitable cause.
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It can fund anything, really.
Crowdfunding Versus Microfinancing
Crowdfunding is a neat derivative of microfinancing, which offers financial services to poor or low-income people.
Generally speaking, microfinance advocates believe that by getting financial services into the hands of the impoverished, you can help them to do some amazing things that can actually break the poverty cycle altogether.
Traditional banks can't handle microfinancing because their overhead required to underwrite a loan precludes those loans from being too small. The same is true of many other financial service offerings. No bank is going to spend the time to underwrite a $50 loan and chase after small bank accounts that might never have more than $100. They just are not built for that.
However, a new breed of microfinancing institutions has evolved and they've been set up in a way that they can make microloans and offer microcredits to folks that previously had no access to such services.
Similarly, crowdfunding is circumventing traditional funding mechanisms like bank loans or venture capital. In essence, it says let's see if we can get a ton of people to chip in a very small amount of money that in aggregate can help somebody to do something.
Crowdfunding Versus CrowdSourcing
Crowdfunding mechanisms tend to have a tipping point built-in to the process that takes popularity of an idea or cause into effect. So, let's say that I have a crowdfunding site that funds small businesses. If a small business only gets 3 people willing to support the entrepreneur with commitments of $5 each, the logic on my site's back-end might say "Punt. Not enough people are willing to back this to really help the entrepreneur out."
On the other hand, if my hypothetical site listed an entrepreneur's money needs and we had 10,000 people willing to commit $50 each, then a trigger might be flagged to actually fund the entrepreneur with $50,000.
In this respect, crowdfunding is also an evolution from what's come to be known as crowdsourcing. That's the idea that a task can be delegated to a crowd. It's applying mass collaboration to get something done.
Think of a piece of meat being dipped in a tank full of piranhas. The meat is gone within seconds as each piranha does his part by gulping down a chunk of meat. That's what I think of when I think of crowdsourcing (sorry to the vegetarians who might be reading this!). It's Web 2.0 technologies applied to the "Divide and Conquer" mantra.
Crowdfunding as a Way to Fund Businesses
I've always thought that the potential for funding entrepreneurs via crowdfunding was a very powerful concept. I thought of it years ago, even before crowdfunding existed as a term.
But I'm certain that it's only a matter of time before crowdfunding overtakes angel investing and other traditional financing mechanisms as a great way to fund a new business concept.
However, there are many challenges. If a small contribution obtained via crowdfunding is actually an equity investment or even a loan, then crowdfunding companies may soon run afoul of securities laws. I forget the details but if you raise money from over a certain number of investors, you start being subject to all sorts of securities laws that are a pain.
If you ask me, those laws should be completely recrafted to allow crowdfunding and kick it into high gear. To me, crowdfunding is fuel for human capital and great projects that is currently untapped but has enormous potential to change the world as we know it. I'm sure there are some advocated at the SEC, the SBA, the Federal Reserve but, no doubt, bureaucracy is frustrating the heck out of them right now. Hopefully, we'll figure out how to tap into the power of crowdfunding soon.
The thing is, it does have to be regulated. I mean crowdfunding scams will be huge, once crowdfunding grows in popularity. When there's money involved, scammers will come.
There also needs to be some liquidity to crowdfunding shares. If people are going to make microinvestments, they will want to be able to profit from their investment. It will be a great day when a firm that raised $100,000 from 20,000 $5 investors sells out for a few million and everybody gets a tidy, albeit little, return on their investment.
The Bottomline on Crowdfunding
Crowdfunding has enormous potential. It's early days right now. Some folks are doing some amazing things, and it's going to get better and better as time goes by! So, stay tuned on this one.