Rewards-Based Crowdfunding: What It Is, When It Works

New business owners usually aren’t the best candidates for small-business loans from banks, which typically require collateral, years of successful operation and excellent personal credit. Even if funding were approved, new entrepreneurs may not have the resources to begin making loan payments immediately.

Rewards-based crowdfunding is an alternative to traditional small-business financing and provides the means to transform promising ideas into a profitable reality — without having to pay back a penny. (Its similarly debt-free counterpart is equity crowdfunding.)

What is rewards-based crowdfunding?

Rewards-based crowdfunding allows businesses or individuals to make a pitch to raise capital through online crowdfunding platforms. This type of financing is geared toward startups, particularly those in creative fields, that don’t qualify for traditional small-business loans but have compelling projects or are looking to test a market. Anyone can contribute to a reward crowdfunding campaign. Since individual donations are often small, the idea is for business owners to persuade as many people as possible to pitch in.

Money raised through rewards-based crowdfunding doesn’t have to be paid back, but in return for donations, businesses provide rewards. A jewelry designer might reward everyone who contributes $100 or more with an original handmade bracelet, whereas an inventor of solar-powered lawn mowers might give a mower to contributors at the $1,000 level. Rewards don’t have to be substantial, though; some businesses simply offer a handwritten thank-you note. Although no loan payments are involved, this money isn’t totally free. Platforms typically charge a fee of 7% to 12% of funds raised.

Funded amounts range from about $1,000 to $100,000. No collateral is necessary, and there’s no need to provide personal or business financial information. Instead, the ability to pitch an idea or product persuasively is critical. Usually, it takes about one to three months to raise and receive funds—but there is a catch. Some crowdfunding platforms have a rule that if you don’t reach your goal amount, your business doesn’t get a cent.

Rewards-based crowdfunding pros and cons

Reward crowdfunding allows small businesses to get exciting new ideas off the ground without the burden of repaying a loan. But there are several things to consider before you pitch your business.

Pros:

  • This is one of the least costly ways to raise capital. Fees are a percentage of the money raised, and businesses may select rewards that let them keep the bulk of each donation.
  • No collateral, credit check or previous experience is needed.
  • The process is simple, with no need to hire professional financial or legal counsel.
  • Businesses don’t give away company shares as with equity crowdfunding.
  • Exposure gained on the platform establishes a customer base and brand awareness.
  • Feedback from donors is valuable for future product development.

Cons:

  • Reward crowdfunding isn’t suitable for businesses requiring funding beyond about $100,000.
  • If you don’t reach your goal, funds may have to be forfeited.
  • Exposing an idea online may put your business at risk of having it stolen and marketed by someone else. For this reason it’s vital to protect yourself with date and time stamps and patents when appropriate.
  • Rewards-based crowdfunding works well for business-to-consumer ideas but doesn’t seem to be effective for business-to-business campaigns.
  • Overly technical or complex ideas may be difficult to pitch.

NerdWallet’s verdict

Since only a limited amount of capital can be raised and only certain types of campaigns are successful, reward crowdfunding isn’t for everyone. For creative startups with strong marking skills needing $100,000 or less, however, this is about as close to free funding as one can get. The additional benefits of connecting with consumers, establishing a brand and receiving valuable feedback for future R&D are icing on the cake.

How to get rewards-based crowdfunding

To start a reward crowdfunding campaign, simply apply on one of the many online crowdfunding platforms. You’ll need a convincing pitch that appeals to as many people as possible and attractive rewards at all donation levels. If possible, feature an entertaining, informative video that highlights your prototype. For the broadest exposure, reach out to family, friends and associates via email and social media. Here are a few of the top platforms for reward crowdfunding:

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As with all financial decisions, be sure to compare all of your business funding options before starting an application:

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For more information on how to start a small business, check out our Small Business Guide.