A primer on Rewards-based Crowdfunding and its functioning
Crowdfunding has evolved in India for years to assist campaigners in raising capital for various causes. Many startups have resorted to different models of crowdfunding to enhance their own funding requirements. Crowdfunding is ideally an excellent practice of raising funds from individuals to back the startup’s cause. Individuals can make a difference with their ideas and opinions, as crowdfunding has put power into the hands of people. Crowdfunding is a complete democratic practice by blending in the support of large people.
Reward-Based Crowdfunding or seed crowdfunding is a small- business financing where individual pools in funds in businesses that interests them in return for rewards in the form of product/service. As the name suggests, this type of crowdfunding has a reward in return for the contribution made. Reward-Based crowdfunding is extensively used for creative projects/ideas. In this type of crowdfunding the backers who entrust their belief in the idea or project presented by the entrepreneurs in the idea and are given rewards in exchange for the contribution made by them.
Reward-Based crowdfunding is suitable for startups that, do not get qualified to get a loan, do not want debts or willing to give up their equity. And is also useful for entrepreneurs who are in the creative field and have a fascinating idea or someone who wants to test the market. Generally, the rewards given are related to the idea or project. For example, a filmmaker would reward its backers with a signed poster, or premier tickets, etc. Usually, the product itself is given as a reward (for eg: a DVD of the film in case of the filmmaker).
Categories of Reward-Based Crowdfunding
- Pre Orders- This is one of the significant methods of giving away rewards. This approach comprises selling pre-order of a product the startup is raising funds to produce. This is a great way for supporters to experience the result of their contribution.
- Services- If the project or idea does not fit to give away pre-orders, the startup can provide its supporters with services in exchange for the contribution made in their idea. For example, startups can prepare home-cooked food for their supporters offering to write code.
- Recognition- This is one of the best present or reward a startup can provide its supporters.Backers who are contributing to the project by making a contribution of less than Rs. 1000 can get some kind of recognition related to the campaign for their support. The recognition can be in the form of a company giving away the T-shirt in accordance with the campaign or including the backer’s name on their website as a way of thanking them for the contribution made.
How Does Reward-Based Crowdfunding Function?
Reward-Based Crowdfunding sounds exciting to the backers since they are getting a benefit from it. Startups depict their idea or product and fundraising goal on a crowdfunding platform. In return for funds, startups provide rewards. For example, a jewelry designer would reward the backers with an original handmade bracelet depending on the substantial amount of contribution made by them.
Below is the step-to-step procedure of how reward-based crowdfunding functions:
- Startups describe their idea or project required for funding on a crowdfunding platform.
- Substantially videos related to the campaign are promoted to involve backers’ interest in the project or idea.
- The owners of the idea share the crowdfunding opportunity with their close network of friends and families.
- Interested backers contribute to the idea and simultaneously share their activities over social networks.
- Post that, backers receive rewards by contributing to the project. Rewards are given based on the funding by individuals, which is determined by the entrepreneurs.
- If the funding goals are achieved before the project’s deadline, either campaign is closed or continues to be over-funded.
- However, many crowdfunding platforms are all or nothing, meaning the crowdfunding platforms return the money funded by the backers if the startup does not reach the specified goal.
- Rewards need not be substantial. Some startups offer a simple handwritten thank you- note to the backers.
Benefits of Reward-Based Crowdfunding
- No risk of losing ownership- with reward-based crowdfunding startups do not have to give away equity in exchange for funds.
- It’s inexpensive – startups have to pay a 5% platform fee and a credit card processing fee of 3% to raise funds.
- No credit check – There is no requirement of a personal credit score while making a crowdfunding campaign.
- No collateral required- there is no risk of giving away business or personal assets through crowdfunding.
Limitation of Reward-Based Crowdfunding
- Not good for large funding amounts – It’s challenging to raise a large amount of capital through reward-based crowdfunding.
- Fixed Funding– Many crowdfunding platforms do not allow startups to keep the funding amount if the goals are not met.
- Exposure to Competitors- Chances may exist where competitors might steal the idea of the campaign.
Therefore, reward-based crowdfunding builds trust for entrepreneurs and creative people such as musicians and designers to raise funds for their idea. Reward-Based crowdfunding helps in bringing early customers for your business, but it yet requires startups to create an exemplary product or service for its potential audience.
It is not just an effective way of raising capital for a new product line, but it also builds fans on a large scale. Companies also turn to reward crowdfunding as it provides the audience for the product to be tested, just to know if the product/idea is a successful launch or not. Due to changing laws and rules, crowdfunding projects are ideally much easier and gaining popularity in India. Crowdfunding platforms are extending their product offerings and are catering to new users of variant types.
As reward-based crowdfunding does not entitle in giving monetary benefits towards the capital contribution made by the backers, it does not fall under SEBI regulations. It is legal to practice in India and is operated by many crowdfunding platforms.