CROWDFUNDING AS A MODEL OF COLLECTIVE FINANCING
Crowdfunding exploded onto the internet a few years ago. Since then early platforms like Kickstarter and Indiegogo have seen hundreds of new crowdfunding platforms emerge onto the scene.
Crowdfunding has emerged as a popular way for startups and small businesses to secure funding outside of traditional routes. Forget seeking out venture capital firms, braving the Dragon’s Den or going to your bank cap-in-hand for a business loan.
Methodical recommendations give you the opportunity to discover how crowdfunding can help your startup raise the finance needed to launch and grow.
Crowdfunding as a alternative way of financing
Crowdfunding for small business is democratising how startups raise money. Investing in a new company was previously the preserve of professional investors. Crowdfunding throws wide the doors so anyone can make a micro investment in a new business that interests them. Funding can be provided by tens, hundreds or thousands of individual investors, as well as institutional investors and their conduits. They come together to provide the money needed to get an idea off the ground, complete production or finance the next stage of growth.
Originally a way for more unique, quirky and less traditional business ideas to secure funding, crowdfunding for small business has grown rapidly. It works by allowing large numbers of people – the ‘crowd’ in crowdfunding – to individually invest small, affordable amounts into businesses. With lots of investors contributing, these small amounts add up to a large, pooled investment that can be used for various purposes by a small business, such as to bring a prototype to market.
The way crowdfunding is presented today brings together many modern elements and new concepts. Even if the ventures and products themselves aren’t technical, today’s platforms are very tech savvy. They are designed to automate much of the processes for fundraisers and funders.
From your phone you can browse almost endless campaigns, and invest with a couple of clicks. Crowdfunding platforms do much of the detail and heavy lifting work for those seeking capital too. Such as payment processing, legal disclaimers, investor updates, and bookkeeping.
The concept of crowdfunding has been around for centuries. Those with capital have always come together to finance bold ventures and back courageous entrepreneurs. Isn’t that how America was discovered and developed in the first place? Today’s crowdfunding enables entrepreneurs to reach more capital partners, and giving investors a broader array of options.
Crowdfunding can raise huge sums. According to Business Insider plenty of UK businesses have secured millions of start up money using crowdfunding platforms. In 2017, Hopster raised £4.8m on Venture Founders for its ad-free TV and learning app for kids, while businesses such as JustPark raised £2.2m on CrowdCube and pay-as-you-go workout business Core Collective raised £2m on Seedrs.
How does crowdfunding work for small businesses?
Online crowdfunding platforms allow businesses to create a fundraising campaign. This is a pitch to investors that includes an overview of the business, business plan, management details and details of the money they want to raise. Depending on the type of crowdfunding platform – such as equity crowdfunding or rewards-based crowdfunding – the campaign will put equity or rewards up for grabs in exchange for their investment.
Investors pledge money during the campaign. Some crowdfunding platforms operate an all-or-nothing approach: if the fundraising goal isn’t achieved then no money is invested in the business and investors walk away. Some platforms such as equity crowdfunding may go ahead and invest the amount pledged at the end of the campaign even if the target wasn’t hit. The crowdfunding platform takes a cut of the money pledged and passes the rest onto the start up.
Crowdfunding isn’t just about raising money. Its community of investors can be a great way to test a product idea and get market insight. If there’s zero interest in a pitched idea, it may be a sign to change course. Ask for feedback from potential investors as to why they gave you a pass.
A word of warning. Crowdfunding isn’t for the faint of heart. You’ll need to actively pitch your business and drive interest to hit your funding goals. Once hit, you’ll need to work long and hard to keep investors updated and engaged, as well as growing your business.
Choosing the Right Crowdfunding Platform For Your Project
How successful your crowdfunding campaign is will largely depend on the platform you present on. It’s important to find a good fit. This is not only true for whether you are taking donations or offering equity, but connecting with the right funders.
There are different types of crowdfunding platforms. All operate in a similar way but take a different approach to the return investors get. Equity crowdfunding, for example, invests in a business in exchange for shares in the firm. Peer-to-peer crowdfunding expects investments to be paid back to investors with interest. Deciding on the best crowdfunding platform is crucial to successfully raising funds and ensuring you’re not giving away too big a stake in your business.
Figure 1. Types of crowdfunding platforms
Some platforms may ban certain types of campaigns, like real estate. Others have spring up to specifically serve niches like the property market. Do your research and find the platform with the best costs, connections to the best investors for your venture, and which will help you get the optimal visibility.
Features of equity crowdfunding
An equity crowdfunding platform allows small business owners to sell shares in their company in exchange for funding. It’s a similar approach to raising money from venture capital firms or angel investors, but with lots of smaller investors buying tiny chunks of equity in your business.
Equity crowdfunding involves a start-up launching a fundraising campaign. This outlines the level of equity available, and how much money it is trying to raise – essentially valuing the business. For example, if a business puts up 25% of equity and wants to raise €250,000, it is valued at €1m. Investors can then buy a portion of the available equity.
Figure 2. Benefits and downsides of equity crowdfunding
Peer-to-peer crowdfunding (or debt crowdfunding)
Peer-to-peer crowdfunding platforms pool investments and lend money to businesses. The expectation is that the startup will be successful and the crowdfunded investment will be paid back along with interest. It’s a similar approach to getting an unsecured loan from a bank. It’s sometimes referred to as ‘debt crowdfunding’. The benefits and downsides of this type of crowdfunding are:
- The funding is unsecured. As you’re not issuing equity or shares, nor tangible assets such as plant equipment or premises, it’s effectively an unsecured loan. Default and you won’t have assets exposed to investors.
- Niche funding. Peer-to-peer crowdfunding is more suitable for less mainstream businesses. It tends to attract investors interested in niche businesses that would find it difficult to secure traditional funding.
- Increased pressure. With the need to repay investors with interest and investors having a keen interest in your day-to-day progress, it can result in added pressure for a startup. The higher interest rates can place an additional strain on resources.
Rewards-based crowdfunding platforms allow businesses to reward investors in ways other than simple equity or interest. Rewards can be the chance to test prototypes, lunch with the founders or getting one of the first models off the production lineRewards are usually tiered, so the more money someone invests, the greater the reward.
Figure 3. Benefits and downsides of rewards-based crowdfunding
This is the best way to raise finance through the sums are usually small. Investors simply donate to your business. No strings. You’ll need to update investors on progress, but any donations you get are yours to keep. The benefits and downsides of donation crowdfunding are:
- Free money given to your business to help it succeed.
- Small investments. Because donations are usually by individuals attracted to your business idea, it’s similar to like tossing spare change into a hat. Don’t expect to raise huge sums through donations.
- Niche businesses. Donations are usually made by people who are supporting social enterprise activities or businesses that support local communities, rather than mainstream limited companies.
How to start the crowdfunding campaign
To get the best from crowdfunding, you’ll need a compelling business case, a detailed business plan, sound financials and robust market insights. Then investigate different crowdfunding platforms and decide if you’re offering equity, interest or rewards to investors. Look at similar business pitches to yours. How much did they raise? How many backers did they attract? Which platforms do similar businesses use? Read the terms and conditions and check fees and the legal commitments you’re making. Take independent financial advice before you launch a campaign.
The next step is pitching. You need to capture the imagination of investors, demonstrate commercial potential and keep it human with presentations by the team. Remember, people invest with head and heart. Establish what investors will get – from equity to access to initial products – and what funding targets need to be met to trigger investments.
Crowdfunding is about community. Be active on forums, talk to potential investors, post updates and use social media to tell people about your campaign to drum up support.
Investors like backing a winner. Get friends and family to make a few ‘investments’ in your business on the platform so it looks as if people are keen to chip in. A few euro in the campaign fund can spark further interest.
Figure 4. Steps of crowdfunding campaign
Your most important network when crowdfunding — is your friends, family and colleagues. They’re the people that support you mostly because they want to see you succeed. Your relationship with them is a big driver of their support.
Figure 5. Network of crowdfunding
At the same time, the most amazing part of crowdfunding is discovering the people you never realized you had a connection with. This tends to be people who your friends share your fundraise opportunity with, through methods like social media, email, or word of mouth.
Your potential customers are people who have an interest in what you’re actually going to produce and would love to be an early customer. They are your “customer zero”. These customers are often discovered through PR that you generate, campaigns through social media, or marketing to existing customers lists.
To truly get the most out of crowdfunding, you need to tap into all three of these methods simultaneously, in order to build a strong network effect in a short period of time.
The risks and advantages of crowdfunding vs. other fundraising channels
Crowdfunding is a new concept and investing in young businesses can be very risky. The main risks of investment-based crowdfunding are:
- The business you invest in might go bust. Many new businesses fail in the first few years, so you could lose all your money.
- The return is not guaranteed. The shares may not rise in value and you may not receive any dividend payment (a share of the profits).
- It may be hard to sell the shares. The shares are normally unlisted, which means you may not be able to sell them easily in the way you could sell shares in a big company that’s listed on the stock market.
- The crowdfunding platform itself may go bust. This could mean you lose money if you’d paid the crowdfunding website but it goes bust before your money was invested with the business.
Due to the abovementioned risk there are some pros and cons to crowdfunding. Though this can vary greatly on the platforms you choose to use.
While crowdfunding is often promoted as an easy and fast way to raise millions of dollars, with little responsibility, it can require a lot of work and investment. Dig into the data and you’ll find some platforms have very low success rates. There can be fees for running a campaign, in addition to payment processing fees (and lag times on receiving money). The experience will also tell you that you should have a sizable marketing budget to promote your offering, and should have at least 25% of your funding goal already committed before going live.
You may retain more control of your business with some of these platforms versus traditional startup fundraising from angels and VCs. Yet, many won’t put you right in touch with the most serious and capable investors. Some of this group may also be turned off by the lack of exclusivity.
Crowdfunding can be very profitable and beneficial. Just make sure you’ve done your research and know the costs, and which channels are the best match before rushing in.
Figure 6. The Three Things Crowdfunding Does Well
There are three main things crowdfunding does well: the platform communicates your idea, that is incredibly valuable; leverages your network, so shareable profile allows you to syndicate your raise across your network, and more importantly, to friends of friends; crowdfunding serves as a central point to push all supporters to in a short period of time, usually between 30 and 90 days.
Recommended sources (if you want to know more)
- Cremades, A. (2019) How Crowdfunding Works For Entrepreneurs. Available at https://www.forbes.com/sites/alejandrocremades/2019/01/12/how-crowdfunding-works-for-entrepreneurs/#1a9851e7c531
- Crowdfunding: what you need to know. Available at https://www.moneyadviceservice.org.uk/en/articles/crowdfunding–what-you-need-to-know
- How Crowdfunding Works. Available at https://www.startups.com/library/expert-advice/how-crowdfunding-works
- The Anatomy of a Successful Crowdfunding Campaign. Available at https://www.startups.com/library/expert-advice/most-successful-crowdfunding-campaigns
- What is crowdfunding? Available at https://www.startuploans.co.uk/business-advice/what-is-crowdfunding/