Which Type of Crowdfunding Is Best for You?

In her book, Cash From the Crowd, Sally Outlaw, founder and CEO of crowdfunding website Peerbackers, reveals the secrets of funding your business with help from colleagues, peers, family, friends and even perfect strangers through a crowdfunding campaign. In this edited excerpt, the author explains the five types of crowdfunding to help you decide which might be right for you.

Even though many people think the term crowdfunding is universal, there are actually multiple options available for those needing to raise funds. These models of crowdfunding basically break down into those that offer a financial return for backers and those that do not.

Choosing the best form of crowdfunding in which to engage is the first decision an entrepreneur must make before moving forward. Options include a donation model, a reward model, a debt model, one that offers royalties, and finally the newest approach, which allows equity (the purchase of company shares in exchange for the backing).

1. Donation. This is the most straightforward approach, in which a contribution is made to a project or cause, and the donor doesn't receive anything in exchange other than a good feeling for supporting something in which they believe (and perhaps a tax write-off). This approach is more often used for social causes, charities and political campaigns, rather than for entrepreneurial endeavors.

2. Reward. This approach to crowdfunding--also called "perks based"--is one in which the campaign contributors get no financial return for their donations but are offered a thank-you reward or perk in exchange for their support. Most often the reward offered is the product that the project owner is trying to launch. This model functions as a sort of pre-sale. Many service companies use this approach and offer things such as a discount on their services. One of its biggest benefits is that you don't have to repay the money, so you're not starting your venture in debt, nor do you have to give away shares of your venture. You just deliver the perks you promised when your campaign is over.

3. Debt, aka peer-to-peer lending. This is where crowds lend their money in small increments to project owners via the platform and expect repayment over time with some fixed rate of interest. The advantage of this model is it may be easier to win support for a campaign since the backers are attracted to getting a return. In addition to the entrepreneur usually getting a lower cost of financing, the entrepreneurs can bypass the sometimes complex and costly application process for bank loans.

An important thing to know about debt crowdfunding is that it usually is targeting a very different user than is targeted by reward platforms. Candace Klein, the CEO of SoMoLend, a debt-based funding platform, points out: "We are usually targeting consumer-facing brick-and-mortar companies--restaurants, retailers, salons, gyms--that already have customers, already have cash flow, and can service debt. Typically we look for a business that is at least a year old and has at least a year's worth of receipts."



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