- Two types: reward-based and equity-based
- No collateral requirement for crowdfunding
- Platform takes a percentage of the funds raised
- Available via online crowdfunding platforms
A decade ago, the idea of crowdfunding as a means of starting or financing small business may have sounded unsustainable. But thanks to the Internet, the practice of empowering small groups or individuals to reach out to masses of people, all for the purpose of raising funds, has become an accessible option for most businesses. Here’s what you need to know before embarking on a crowdfunding campaign.
What is Crowdfunding?
Crowdfunding (also called “crowd financing,” “crowdsourcing,” or “crowd-sourced capital”) mobilizes a group of people to dedicate small amounts of money towards a common goal, such as the creation of a product, the funding of a non-profit, or the birth of a small business.
Today, crowdfunding campaigns are generally launched and orchestrated on the Internet via websites such as Kickstarter, Indiegogo, and Wefunder. Each one of these platforms has its own requirements and restrictions for projects related to the type of campaign, the monies raised, fees involved with the site, whether or not equity is available, and if backers will receive a tangible product or benefit in exchange for their support.
Here’s a breakdown of the biggest crowdfunding sites.
- Kickstarter is the largest and most well known crowdfunding site, with more than 5.5 million monthly visitors. The site reports that more than $1 billion has been pledged to over 63,000 projects on its platform alone.
- The site takes a 5% cut of the funds raised.
- Projects are limited to creative endeavors/for-profit companies (Kickstarter does allow non-profits, but doesn’t offer direct cause funding) such as those focused on art, technology, theater, fashion, food, music, etc.
- Projects must reach their funding goal in order for creators to receive their funds. Otherwise, creators get nothing.
- Creators are encouraged to offer tangible rewards for pledges.
- The site receives more than 900,000 monthly pageviews.
- Indiegogo has a few funding options. For all or nothing, it takes 4% of funded dollars. For flexible funding, it takes 4% of successfully funded projects and 9% of unsuccessful projects.
- Unlike Kickstarter, Indiegogo allows a wide range of projects and for-profit businesses (not just creative). The site is also a good option for non-profit ventures.
- Creators are encouraged to offer tangible rewards for pledges.
- A unique crowdfunding platform that allows investors to purchase equity with their pledges.
- The site is best for for-profit companies, not non-profit ventures.
- Note: as of spring 2014, the SEC only allowed equity investment from accredited, high-wealth individuals. This is expected to change later in 2014 when regulations for the JOBS Act are ironed out.
How Crowdfunding Works
Crowdfunding allows entrepreneurs to post a request-for-funding campaign online, send that campaign out to their networks, and collect money.
Each platform has a different way of releasing funds; some use Amazon Payments while others use direct deposit, PayPal, or wire transfer.
Kickstarter subscribes to an “all or nothing” model. Campaigns that fail to meet their full goal amounts (which are determined and stated at the beginning of the campaign by the business owner) are voided and any monies pledged are returned. Other sites are more forgiving, letting entrepreneurs collect the money they raise even if they didn’t meet their goal.
Some crowdfunding sites like Wefunder and Portfolia allow small business owners to offer an equity stake in return for a monetary donation. Others like Kickstarter and Indiegogo suggest offering a sliding scale of tangible rewards as incentives for donation. For example, if a theater company was looking to raise money to open a new performance venue, its campaign may offer two tickets in return for a $50 donation, or a private performance for a $500 donation.
Is Crowdfunding Right for My Business?
While crowdfunding can be an exciting option for small business owners, it isn’t always the best solution. For example, if you plan to look for traditional financing (VC money, angel investment) later in your company’s lifecycle, you may want to think twice about crowdfunding. Traditional investors tend to look down upon crowdfunding campaigns as amateurish and lacking in credibility (there are exceptions to this, but overall, it is a bias).
Here are a few other reasons not to launch a crowdfunding campaign:
- You haven’t tapped your personal network yet. It is advisable to ask friends and family for money before enlisting the help of a crowdfunding portal, especially if you think those people may be your only investors (sites take a percentage—money that you could keep if you didn’t use the Internet).
- Your business or product is not entirely fleshed out. Make sure you can deliver on your promises before launching a campaign.
- You don’t have the time to dedicate to the project. Successful crowdfunding campaigns are time-intensive; block out a few hours a day for the duration of your project for the best results.
As far as paperwork goes, the SEC requires several documents for crowdfunded businesses. These include financial disclosure documents and annual business reports.
How to Run a Successful Crowdfunding Campaign
Crowdfunding is an option for small business owners who may have already tried and failed with traditional financing, entrepreneurs with a general lack of funds, and those who’d rather not go the traditional route at all. If marketed and run correctly, a crowdfunding campaign can be wildly successful, even if the business is virtually unknown, has no financial track record, or has yet to be founded.
One of the most successful crowdfunding campaigns thus far was Pebble E-Watch, a smart watch created by Pebble Technology. The company launched the campaign in 2012 with a goal of $100,000, and ended up raising pledges of more than $10.2 million.
Another successful example: video game company Ouya launched a campaign to fund its gaming console. With an initial goal of $950,000, the company was shocked when they received $8.5 million in pledges. The secret to their success? A strategic (but not complicated) digital marketing campaign in which the founders tapped into their social network and generated consistent buzz in the media.
Crucial Steps for Meeting Your Crowdfunding Goals
Running a successful crowdfunding campaign takes more than just posting an idea and waiting for backers to flow in. Here are tips to help companies meet their crowdfunding goals:
- Set a specific strategy. Do your homework before launching a campaign. Test the market to see if your product or service is of interest to potential customers. Explain your idea to as many people as possible to gauge their interest. Then, when you’re ready to launch, reach out to your network and explain your campaign, including the specific date/time when it will go live and how much you would appreciate their support.
- Create a plan. Make a schedule for posting on social media during your campaign and reach out to industry media outlets. Organize events to increase awareness. Do everything you can to keep the momentum going while your crowdfunding project is online.
- Ask for pre-pledges. According to the Small Business Administration, the most successful crowdfunding campaigns go live after getting 20 to 30% of funding secured by initial backers. Reach out to your network for pledges before your campaign launches. This strategy may encourage others to pledge if they know a lot of people are already involved.
- Test your rewards. Some backers may only pledge if they see value in the rewards or incentives. So test them out beforehand. Are they enticing enough to translate into pledges? If you’re offering equity, are you offering enough of it to grab real attention?
- Reach out to your network. Leverage any contacts you may have in the media or digital influencer worlds. It could be someone you know who runs your local news site, or your friends with the most Twitter followers. This is the time to pitch them your business and request their assistance in getting the word out. Also reach out through your social media networks using tools like Twitter, Facebook, and Google+.
- Stay on top of your campaign throughout its duration. Your crowdfunding campaign should be a primary focus during the entire time it’s live. The more time you put into it, the more attention you’ll garner and the more money you’ll get. Get creative and exhibit enthusiasm. Your energy will attract the energy of others who want to help.
Pros to Crowdfunding
Crowdfunding can be a great way for startup companies to gain access to capital for a product or service, or to find equity partners. It lets entrepreneurs cast a wide net and puts them in contact with people they may not have known otherwise. The model also generates excitement among potential future customers of a business (creating a network of backers that will look forward to the product’s launch).
And aside from the time you need to put in, the upfront costs are minimal and the barriers to entry are low – you don’t have to apply, or have any financial history, good credit, or other metrics.
Cons to Crowdfunding
There are no guarantees. You may not reach your goals, and you may collect little to no money. And if you do reach your goals, you may be on the hook to reward all those expectant backers with one of the incentives you promised, such as free tickets, or the product itself. As such, it’s important to have a solid business plan, and prepare to create and deliver all that reward inventory well before you launch the campaign.
To Sum Up
Launching a crowdfunding campaign can change the game for small businesses. Before opting for this mode of financing, do your homework and plan carefully. A successful campaign will require time spent in market research, business planning, networking, marketing, and developing a solid plan for promotion.