When your business should use crowfunding to grow
- Hosted December 28, 2018
- By Eric Goldschein
One of the most difficult issues that any small business owner faces is how, when, and where to find funding to help their business grow. Even if you have a successful startup, you may not have the capital needed to take advantage of rising demand.
Some small business owners take a conservative approach, and don’t spend money they haven’t made yet on upgrades, expansion, or other improvements. Others take on the risk of obtaining a business loan, using their newfound capital to jumpstart growth and (hopefully) repay their lender.
There are pros and cons to both methods. That said, a middle-of-the-road approach like crowdfunding may appeal to those who want access to funding without assuming massive risk.
Crowdfunding is an increasingly popular way to raise capital for a small business, whether your concept is in the idea stage or you’re looking to unveil a new product or service that brings your business to the next level. But is it always the best option? Let’s review how crowdfunding may, or may not, work for your business.
What is crowdfunding?
Crowdfunding is a method for financing a business, project, or idea, based around raising small amounts of money—as little as a few dollars at a time—from various individuals. These individuals can be family members, friends, or strangers on the internet who are compelled by your presentation.
Although there are different types of crowdfunding, the general principle remains the same:
- An entrepreneur, inventor, and/or business owner shares a presentation or pitch on a crowdfunding platform like Kickstarter.
- Internet users can read product descriptions, review photos and videos of current iterations, and otherwise learn about an idea before committing funds to the project.
- Business owners then take that money and apply it toward their idea.
The world of crowdfunding has proliferated over the last few years, with hundreds of different platforms with varying focuses and audiences now available for entrepreneurs to use as launching pads for their businesses. As a result, crowdfunding revenue is expected to hit $300 billion by 2025.
With that in mind, when exploring crowdfunding, be sure to identify which platforms are the best fit for your business and project and review best practices for raising the funds you need.
What are the different kinds of crowdfunding?
If you’ve heard of crowdfunding, you probably have an idea of how it typically works. Users contribute money to your project, usually in exchange for some sort of reward—one of your products, or recognition on social media—until you reach your stated goal.
But just as small business financing has expanded in recent years, so too has crowdfunding. Here’s a rundown of the four main types of crowdfunding and why they might appeal to you:
This is one of the best-known crowdfunding models. With rewards-based crowdfunding, you offer an incentive (material or otherwise) to users for investing in your idea. You may offer different “tiers” of rewards or incentives depending on how much a user contributes, from a shout-out via social media to an item pre-order to other merchandise.
Also known as seed crowdfunding, this method is popular because businesses can offer non-monetary or low-cost rewards in exchange for investments. The goal, of course, is to not materially affect the amount of money you take in from investors. Only high-level contributors should receive costly rewards, such as branded swag, or in-person experiences that will cut into your working hours (e.g., bringing a backer to visit your workspace, or taking them out to dinner). Check out this list of 96 reward ideas for inspiration.
Equity financing is when you essentially sell a piece of your business to an investor, sacrificing complete control of your venture in exchange for the money to grow.
Crowdfunding with equity is similar—you’ll sell off chunks of your business to a varied group of investors, who then become part owners. As part of your crowdfunding project, you can set minimum amounts and/or maximum investment caps to maintain majority control.
Unlike rewards crowdfunding, there is no expectation of an incentive for people to invest in your concept. Particularly popular with non-profit-based initiatives, donation crowdfunding is how organizations with limited resources use the power of crowdsourcing to meet their goals.
Some donation-based crowdfunding efforts have donation matching—you, or a third party, will match any contributions made by backers, helping them feel that they are contributing double whatever they’ve committed to your business.
An example of a popular donation-based crowdfunding platform is GoFundMe.
Debt crowdfunding is similar to a business loan, except that your lender is many individuals rather than one organization like a bank or online lender. Your lenders will extend you the money you need, but you’ll have to create a schedule for paying back their investment, plus interest, over a set time period.
Using crowdfunding to engage in debt financing gives the business owner more flexibility and options than if they went with a traditional loan.
When does crowdfunding make sense for my business?
Virtually any small business can use crowdfunding at any time. It’s a low-risk option with few barriers to entry. There are, however, some situations where crowdfunding makes more sense for small businesses—and since it takes time and resources to come up with a compelling crowdfunding presentation, it’s in your best interest to decide ahead of time whether this is a possibility for you:
You’re not interested in a drawn-out loan process
The best and most affordable small business financing options typically come courtesy of a traditional bank. Long-term business loans from a bank can have relatively low APRs and generous repayment terms. Unfortunately, we measure their underwriting and decision-making processes in months, not days.
You can set up a crowdfunding campaign in one day, and although you can typically run one for as much as 60 days, 30 days will bode better for your chances of success.
Best of all, you won’t need to submit tax returns, credit reports, balance sheets, or anything else a lender might require. You just need to make a convincing case for why you’re a good bet, based on the strength of the idea itself.
Your business (or personal) credit history is lacking
Two of the biggest factors in whether a bank or lender will extend you a loan are your business and personal credit scores. If you don’t have much of a credit history, or have had some trouble will paying off personal debts in the past, you won’t get many affordable loan offers until that changes. There is no such review process in most forms of crowdfunding.
You need validation or exposure
Another benefit of crowdfunding is that it also functions as a form of validation and exposure for your idea. Is your small business more of a side hustle or hobby, and you want to see how viable it would be as a full-fledged business? The response you get when running your crowdfunding campaign may be the social proof you need to take things to the next level.
What are the drawbacks of crowdfunding?
Crowdfunding isn’t a perfect form of potential financing. There are some variables to keep in mind, including:
Low overall amounts
If you need a sizeable investment in your business, crowdfunding may not be the way to go: The average successful campaign raises about $7,000. Although that’s a fine amount of money, you may need something more substantial, such as a grant, loan, or venture capital investment.
High failure rate
The crowdfunding space is competitive, and reportedly less than a third of all campaigns meet their goal. You’ll have to put plenty of time and resources into your campaign, and even then you may not get the funds you require: Certain platforms don’t allow you to have access to any money pledged unless you reach your stated aim, which means you may end up with nothing to show for your efforts after 30 or 60 days.
The stakes for failure appear relatively low at first, but consider the effort it takes to put together a campaign—and how it counts for nothing if you don’t reach your goal. Would your time be better spent cutting costs and evening out your cash flow? Or applying for a business loan, the process for which is mostly out of your hands? A high degree of confidence in your concept is practically required in order to make this worth your while, and you’ll need a Plan B on hand in case you don’t succeed.
Though they don’t come close to the interest rates of a bank loan or credit card payment, most platforms charge you a fee for using their service, which means a chunk of your crowdsourced funds won’t go toward financing your needs.
Sharing your business idea or new project on an open forum gives competitors and fraudsters the ability to steal your concept and bring it to market before you do. This isn’t as big a deal for already-established businesses, but for entrepreneurs still in the planning stages of their business should take the time to protect their intellectual property with patents, unique branding, and a plan for manufacturing ready to go.
Crowdfunding can be an avenue for fundraising for nearly any small business. It’s particularly handy for new businesses, business owners with a limited credit history, and those with smaller capital needs. If you have creative slide decks, ideas for fun rewards, and the social media channels needed to share links to your campaign, you’re in a great position to take advantage of this burgeoning industry.
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