Crowdsourcing vs. Crowdfunding

When I started practicing law 17 years ago, the terms “crowdsourcing” and “crowdfunding” did not exist.  Both were coined around the same time and are often confused with each other. I have experience with both, so I thought it might be helpful for me to provide some guidance on the proper use of each term.

Crowdsourcing

The creation of the term “crowdsourcing” is commonly attributed to the editors of Wired magazine in 2005. It is a combination of the word “crowd” and “outsourcing” and is used to describe the process of outsourcing to a large group of people (typically via the Internet). Companies seeking a solution to a problem may publish a description of their challenge (often referred to as an “open call”) and invite contributors (the “crowd”) to submit solutions.

The definition and use of crowdsourcing has evolved over the years. One example of crowdsourcing (the one with which I am most familiar) involves companies who issue an open call to inventors or problem solvers to help the company with a new product or service offering. These open calls might be for something as simple as a new toy, kitchen gadget, or pet product. In other cases the company might be seeking specialized knowledge to overcome a scientific or engineering challenge.  These are examples of “competition crowdsourcing” where there are multiple (sometimes thousands of) submissions but only one “winner” is chosen. The winning submitter is typically awarded a prize, which may be a cash payment or promise of future royalties based on the sales of the product or service incorporating her winning submission.

A variation of competition crowdsourcing is known as “open collaboration crowdsourcing”.  Rather than keeping each submission private and selecting one “winner”, the submissions are available to be viewed by others. This allows submitters to work together to improve upon each others’ solutions. The hope and expectation with open collaboration crowdsourcing is that, by working together, the problem solvers will ultimately generate a better solution than they would have if they had each worked alone. Under this scenario, each individual who contributed to the chosen solution is compensated.

Another example of crowdsourcing involves the virtual labor market. Numerous online platforms have emerged in recent years that allow companies to post jobs and invite contractors to bid on them.  This type of crowdsourcing is ideal for businesses that have specialized needs from time to time, but their need doesn’t justify hiring a full time employee. For example, a company might need someone to edit training videos one month, design a new logo the next month, and build a new website the month after that.  Virtual labor market crowdsourcing offers a good option to have numerous contractors, each with their own set of skills and experience, compete for each job without the company having to undertake the administrative and strategic burdens associated with identifying and hiring an employee.

Crowdfunding

Crowdfunding, on the other hand, is the practice of raising money for a venture from a large number of people.  Like crowdsourcing, crowdfunding typically involves publishing a request to a broad audience over the Internet. The similarities end there.

The origins and history of crowdfunding are difficult to pin down. Some people claim that crowdfunding pre-dates the Internet in the form of various subscription models, war bonds, and other projects that involved a large number of financial supporters.  For modern purposes, however, crowdfunding took hold upon widespread adoption and use of the Internet. It is generally accepted that the first public use of the term “crowdfunding” was in 2006.

Music, film, and software projects were the first to raise funds through the modern crowdfunding method. These early projects (and all others of which I am aware prior to 2012) were examples of “rewards crowdfunding”.  As the name implies, rewards crowdfunding invites individuals to contribute money to a project in exchange for a prize or reward. The more money an individual contributes, the better the reward. To use a musical recording project as an example, a low level contributor might received an autographed CD as a reward, whereas a mid level contributor might get a CD, t-shirt, and a poster, and a top level contributor might get the musical artist to come perform in their living room.

In recent years, federal and state legislation has enabled a second type of crowdfunding – equity crowdfunding.  With equity crowdfunding, contributors are more like traditional investors because they receive equity (i.e. an ownership interest) in the company to which they are contributing. This provides investors with an opportunity to earn a profit on their investment (or, as more often happens with traditional startup investments, get nothing back).  There are some other crowdfunding models (such as peer-to-peer lending), but these days most people who mention crowdfunding are referring to rewards crowdfunding or equity crowdfunding.

Summary

If you ever get confused by the terms crowdsourcing and crowdfunding, just think of the words themselves. Crowdsourcing is outsourcing to the crowd; Crowdfunding is getting funding from the crowd.