Many small business owners experience difficulty in securing funding from traditional lenders, with as many as 67% of them looking into alternative sources of financing. One such alternative is crowdfunding—the practice of using the financial resources of many to meet the funding needs of a business or other venture.
Traditional banking actually fits this definition, like a traditional Savings and Loan, where the deposits of many are lent to individual borrowers. With crowdfunding, the internet has re-defined that pool of potential lenders to include nearly everyone, and the implications of that change have revolutionized the way many startups and small businesses approach their funding needs.
Crowdfunding Platforms: Rewards vs. Equity
In a traditional banking model, there are three entities involved in the business loan process: the asset holders (depositors in the bank), the bank itself, and the borrower. In crowdfunding, the asset holders are the crowd, the bank is the platform, and the borrower is the small business or startup seeking funds. There are basically two kinds of crowdsourcing platforms: rewards based and equity based.
Rewards based crowdfunding offers incentives to backers that can vary by the project being funded, and may include special access to exclusive events or new products, or even special pricing. In a rewards based model, the entrepreneur incurs no debt. Two types of reward based crowdfunding are common: the ‘keep it all’ model, where fund seeking entities keep all money raised regardless of whether their target goal is reached, and the ‘all or nothing’ model, where a fundraising goal is set and unless it is reached, all monies are forfeited.
Investors seem to prefer ‘all or nothing’ strategy initiatives. Not only does the “all or nothing’ fundraising model generally require a more detailed business plan, but investors may believe that a product of lesser quality might be released if a target goal is not met.
Equity based crowdfunding offers a percentage of the company to lenders in exchange for needed funding. In this model, owners are actually selling a portion of their business, and it is imperative that the business understands all the implications of such an arrangement. Consultations with both an attorney and an accountant are prudent.
Regardless of which type of crowdfunding you choose, be ready for the price-tag. Fee structures can vary widely, but success fees are the most widely used. A success fee is a percentage of the total amount of funding raised, and it is only collected if you meet your funding goal. Most platforms charge between four and ten percent, and some crowdfunding platforms also charge carried interest on top of a success fee.
As always, checking the fine print on any crowdfunding option is a must. And think about your time frame carefully. Crowdfunding platforms all come with a start and end date, so you’ll want to have all your preparations complete before the official start of your campaign.
Developing a Crowdfunding Plan
Crowdfunding, at its heart, is a kind of marketing. A good crowdfunding campaign will have a comprehensive strategy, including a solid business plan and professional, carefully constructed campaign videos. Much like applying for a loan, using crowdfunding entails selling your idea to potential backers.
You will need to have a strong voice and clearly articulated vision for your business in order to attract the crowd necessary to secure the funding. Be able to explain the need your new business will meet, and make sure your market size is compatible with the service your business will provide.
How Much Crowdsource Money Will You Need?
If you’re thinking that the more money you can raise, the better, it’s time to think again. Not only do many of the more successful crowdfunding platforms offer only the ‘all or nothing’ option in which all of your hard work could result in nothing if the goal isn’t reached, setting too high a goal can result in disappointment as well, and limit your future funding options.
In addition to having realistic goals about how much funding your venture will need, another viable strategy is to not ask for everything at once. Focusing your crowdfunding solicitations on smaller phases of business development can allow you to proceed incrementally, build momentum, prove your concept, and pave the way for a future round of crowdfunding. Remember, once you’ve received the funding for a particular phase, you’ll need to deliver on on the success. When you do, it can prove to investors that a second round is worth their support.
Start Crowdfunding Before You Launch Your Campaign
Anyone who is considering crowdfunding for their business has undoubtedly considered other options for fundraising. Before launching your official, timed campaign, you should have some initial investment in place. The psychology of an online fundraising campaign involves momentum and buzz, and one sure way to generate at least a bit of that in the early stages is to get some initial support.
Putting together a ‘starter crowd’ of friends, family, and sympathetic acquaintances to make early contributions when you officially start your campaign can help draw the crowd that crowdfunding depends on, and get potential investors interested. If you can create an atmosphere of success around your venture, new investors are more likely to flock to it. After all, nothing succeeds like success.
Which Crowdfunding Platform is Right for My Business?
There are literally hundreds of crowdsourcing platforms, and many are tailored to specific entrepreneur’s needs. Kickstarter is probably the most famous, and though it was originally used almost exclusively by artists, it has become a go-to source for financing innovative new products. But they are picky: Kickstarter takes only about 60 percent of the projects that apply, and they focus almost exclusively on projects of an artistic or creative nature.
Indiegogo takes more of an anything goes approach—if it’s not illegal or pornographic, you can use it to raise capital. While this approach guarantees that your campaign can get started, it will also compete with many thousands of other ideas.
Whichever crowdfunding platform you choose, make sure to do your homework, plan your campaign carefully, and consider the bigger picture. Most likely, crowdfunding will be only one part of a comprehensive business strategy.
What if My Crowdfunding Plan Doesn’t Succeed?
If your crowdfunding plan fails to get you the required money to launch your startup, keep in mind that many successful businesses have been started by using a luxury item like a diamond ring or valuable Swiss timepiece as collateral for small business loan.
Diamond Estate Jewelry Buyers (DEJB) is a leader in these types of collateral loans on fine jewelry and watches. Depending on the value of your item(s), you could qualify for an immediate loan upwards to $50,000 (and beyond). Contact DEJB today for a free loan consultation and appraisal of your luxury collateral.
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Learn more about more options and strategies for financing a business venture, in our knowledge article: How to Fund a Startup.