Understanding and Using Crowdfunding for Your Small Business
A crowd of pedestrians walking down a city street
At some point in your journey as an entrepreneur, you may need help financing your small business. Whether you need additional funding to get started or to expand, there are several different types of lenders to choose from, such as banks, micro-lenders, community development loan funds, venture capital and angel investors.
For startups and new businesses, one option to consider is crowdfunding. Using crowdfunding, you receive contributions from a large group of individuals, usually on internet platforms like Kickstarter, Indiegogo, RocketHub, and Peerbackers. Contributions can be as little as $20 or as high as $1,000 or more. Many successful businesses and products have been launched with crowdfunding, such as the virtual reality headset Oculus Rift, the smart home security device Canary and the popular card game Exploding Kittens.
Types of Crowdfunding Campaigns
There are several different types of crowdfunding campaigns you can use to finance your small business, the most popular being rewards-based crowdfunding and equity crowdfunding.
With rewards-based crowdfunding, contributors receive a reward for their financial investment. This reward is often the product that the business is raising money to create before the public has access to it and at a discount. For example, when Pebble ran a Kickstarter campaign for their E-Paper Watch, early backers who contributed $99 received a black Pebble watch as their reward, which would later retail for $150.
With equity crowdfunding, contributors receive shares of the company in return for their financial investment. While anyone can contribute to a rewards-based campaign, equity campaigns are reserved for accredited investors only. Equity crowdfunding is usually used by businesses that need to raise more than $100,000.
Another type of crowdfunding is donation-based, in which backers don’t receive any type of reward or financial incentive for their contribution. This type of crowdfunding is usually reserved for charitable causes and nonprofits.
Advantages of Crowdfunding
- Money does not need to be paid back.
- It does not require collateral, a credit check or operating history, unlike applying for a loan.
- Instead of shopping your business plan around to multiple investors, you can package your business idea into an attractive website once, which anyone can visit and contribute money to.
- Access to a wide range of investors, not limited to your personal network or geography.
- Contributors often post about the projects they support on social media and tell their friends, leading to greater awareness of your business.
- You’ll receive feedback on your business idea before it’s finished, allowing you to improve your product or service. Some businesses capitalize on this crowdsourcing aspect, allowing contributors to help create the product themselves.
- Once your campaign is finished, you’ll already have an established customer base, many of whom will feel personally connected to your brand.
Disadvantages of Crowdfunding
- Most internet platforms charge fees. Kickstarter and Indiegogo, for example, both deduct 5% of your earnings and also charge a processing fee of 3-5% for each transaction.
- Most internet platforms don’t allow you to keep your funds if you don’t reach your goal, so your campaign could end up being a waste of time.
- If you underestimate how much money you need, you may struggle to deliver the product and any rewards you promised.
- You could miss out on the support and mentorship that angel investors or even banks often provide.
- Before starting your crowdfunding campaign, think through how much money you need and what you need it for.
- Make your campaign website compelling, with high-quality images or a brief video, a clear explanation of your project, why people should invest and what you will do with the money.
- In the beginning, ask your friends and family to contribute. Once people start donating, others will typically follow.
- Include reward levels. For example, contributors to the Veronica Mars movie received a copy of the script for pledging $10, a copy of the DVD and a making-of documentary for pledging $50, and the movie’s lead actress, Kristen Bell, recorded a personal outgoing voicemail message for those who pledged $500.
- Answer all questions and comments from contributors in a timely manner.
- Promote your crowdfunding campaign site on social media, in blogs, on YouTube and tell your friends.
Now that you know the pros and cons, consider using crowdfunding to get your own business started. Before launching a crowdfunding campaign, complete section 4 of MOBI’s business plan template, “Financing.” For more help with getting your business up and running, including help with financing a small business, sign up for MOBI’s Starting a Business course.