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How does crowdfunding work?

Modern crowdfunding emerged in the early 2000s as a new way of financing music and culture. It started to grow rapidly in 2008 in the aftermath of the financial crisis, as traditional funding sources (such as bank loans) became harder to come by. Advances in technology have also contributed to its popularity – the internet has made it radically easier to connect potential funders with people looking for funding, whatever the cause.

There are four main types of crowdfunding offering very different financial instruments and differing vastly in the amount of money that can be raised through them:

Donations-based

Individuals donate small amounts towards a specific charitable project while receiving no tangible benefit except for seeing the project go ahead. The average amount raised through this model is £714.

Rewards-based

People contribute to projects and receive a tangible, but non–financial, reward return such as a product or tickets to an event. The average amount raised through this model is £6,326.

Equity-based

Individuals invest in equity or profit/revenue sharing in a project or business in the hope of making a financial return if the business exits. The average amount raised through this model is £523,978.

Lending-based (AKA P2P-lending)

Individuals or businesses seeking a loan apply through the platform, with members of the crowd taking small chunks of the overall loan. Investors make a profit when the loan is repaid with interest. The average amount raised through this model is £76,280.

At the heart of most crowdfunding is the idea of a ‘platform’: a mechanism, usually a website, that allows would-be investees to make offers to funders and helps the two parties interact. Kickstarter, Crowdfunder, Zopa, Crowdcube, Seedrs and Funding Circle are all examples of platforms.

Nesta's work on crowdfunding

Nesta has been involved in the alternative finance sector since 2010, working to understand how new methods of finance can be used to bring innovative ideas to life. We have sought to support and inform the development of crowdfunding, through research and practical programmes – creating directories, practical guides and tools – and bringing platforms and regulators together to shape the market.

From 2012 to 2016, our market studies – developed in partnership with the University of Cambridge and the majority of platforms in the market – mapped the growth and key trends in the crowdfunding market. We documented how the sector grew from a few startups at the fringes of the financial sector to, in less than a few years, a billion-pound market that plays a significant role in how people in the UK invest their money and businesses raise finance.

In 2013, to help fundraisers and investors navigate the market, Nesta launched both the UK’s first directory of crowdfunding platforms CrowdingIn.com and a guide called Working the Crowd to provide practical advice on what crowdfunding is and how to develop a campaign.

Alongside our market studies, we have also explored how specific models operate and considered the potential policy interventions to support their growth. The Venture Crowd (2012) analysed the UK equity crowdfunding market and Banking on Each Other (2013) subsequently looked at the emerging field of P2P lending for small businesses, drawing on data from Funding Circle.

Through our practical programmes and experiments, Nesta has also sought to support innovation in the market, specifically with a focus on how crowdfunding can be used to fund projects with a social purpose. In 2016, Crowdfunding Good Causes explored opportunities and challenges in crowdfunding for good causes, focusing on the needs of charities, community groups and social entrepreneurs.

In 2013, through the Innovation in Giving Fund, Nesta supported three organisations that were using the crowdfunding model to increase levels of charitable giving. These included buzzbnk (now FundIt), which specialised in social venturing, Solar Schools, which helped schools fundraise for renewables, and Peoplefundit (which has since become Crowdfunder), which supports a range of projects and startup ideas, including creative projects.

Our ongoing work in this space looks at crowdfunding for philanthropy and good causes, and how to combine the approach with institutional funding.

Case studies

Matched Crowdfunding for Arts and Heritage Pilot

In 2017 Nesta set up a matched crowdfunding pilot in collaboration with two UK-based funders, Arts Council England and Heritage Lottery Fund, each of which provided £125,000 of grant funding for arts and heritage projects raising between £4,000 and £40,000 through crowdfunding.

Further resources