Crowdfunding your startup business: Everything you Need to Know
Is crowdfunding a viable option for financing your small business startup? Part one.
Sure there are lots of economic programs and incentives for small business startups available. But, as you probably know, many small businesses don’t qualify due to difficulties related to building up credit and providing the needed financials to secure loans and lines of credit required for startup and growth.
Obviously, as an entrepreneur, obtaining financing is one of the biggest hurdles you have to overcome. If a bank loan won’t cover what you need and you don’t have connections to investors, it can be tough to know where to begin. Additionally, the sluggish economy has made access to capital even more difficult, forcing many small businesses to look for alternatives to traditional lending.
Online crowdfunding…raising smaller amounts of money from multiple backers…has become an increasingly common alternative financing solution for entrepreneurs, in large part because it bypasses the need for collateral and offers less risk.
What is crowdfunding?
Crowdfunding is the financing of a business project by a group of individuals (the crowd), replacing more traditional modes of business financing by professional “accredited” entities (banks), and individuals (venture capitalists or business angels.)
Typically consisting of relatively small contributions from a large number of people raised on the internet, crowdfunding is a combination of the concepts of crowdsourcing…different in that crowdsourcing typically involves getting crowd input for business-related tasks, processes and ideas relating to customer service, labor, design, etc. that are essential to the production or sale of products…and microfinance, which is small amounts contributed with no collateral.
As society grows more comfortable with internet transactions, the world of crowdfunding is rapidly expanding. Since 2005, one crowdfunding website alone has facilitated funding for over 600,000 entrepreneurs. One study found that the median amount raised for each entrepreneur was $28,583, but the amounts can get much larger as evidenced by the fact that the biggest amount raised in that same study was $82.1 million.
What are the benefits of crowdfunding for the entrepreneur?
Crowdfunding can be a great source of alternative financing because it allows businesses to reach out to a large number of potential investors at once, it often doesn’t involve giving up equity or accumulating debt and, along with providing needed funding, it can also provide validation, feedback and exposure as well.
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Specific crowdfunding benefits can include:
- Crowd or funding? Surprisingly, it may be that the “crowd” is more important than the “funding” for a number of entrepreneurs. According to a recent survey of projects on the crowdfunding platform Kickstarter, by Wharton’s Ethan Mollick and the University of North Carolina’s Venkat Kuppuswamy, 70 percent of successful entrepreneurs said they used crowdfunding “to see if there was demand for the project.”
54 percent said “the project could not have been funded without raising the goal,” and 30 percent said they turned to crowdfunding because “other traditional financing options weren’t available.” Validating ideas, testing markets, launching brands, finding customers and impressing investors were all reasons for using crowdfunding expressed by entrepreneurs in the survey.
- Faster, easier, no upfront fees. Crowdfunding can save you significant time compared to pursuing normal financing options, which often consist of painfully frustrating, time-consuming processes. Time, as you know, often seems to be in short supply for entrepreneurs. In order to get started on the crowdfunding path, you only need to contact the platform that best suits your purpose, share your powerful message, make a video, and establish some attractive rewards.
- Help refining your idea. Because you’re engaging a crowd, crowdfunding can be a great source of brainstorming and feedback enabling you to refine your business concept, while also identifying weaknesses in your business plan or holes you may not have considered.
- Get a head start on marketing and acquiring customers. Members of a crowdsourcing campaign are in effect, early adopters, who can not only spread the word, sharing with friends and family, but can also become loyal customers. Plus, a committed crowd is likely to result in better customer acceptance, and more awareness of the business.
Additionally, many crowdfunding platforms incorporate social media mechanisms, making it painless to get referral traffic to your website and other social media pages, while also promoting viral marketing. A successful crowdfunding campaign can provide exposure that is in effect, free PR.
What is it about crowdfunding that motivates investors?
Investors are either financially motivated, or they’re motivated by the opportunity to participate in innovative projects for pleasure or fun, to be able to say “I did it”, to obtain recognition and personal satisfaction, or to get rewarded with early access to the product or service, a collector’s edition, or invitations to special events, for instance.
Investors that don’t have a solid networking structure in place, can find it difficult to identify opportunities for investing in early-stage companies. Crowdfunding can increase exposure to a wide range of opportunities, without geographic barriers, can make diversifying portfolios easier and allows investors to get a glimpse into the companies they’re investing in, and network with a other investors, before taking the plunge.
It used to be that only accredited investors could participate; now everyone can.
Before the JOBS Act was fully implemented, equity crowdfunding was limited to accredited investors, defined by the SEC as individuals who consistently earn more than $200,000 per year, couples with consistent combined income of more than $300,000 per year, and individuals whose net worth (excluding primary residence) is at least $1 million.
Changes to the JOBS Act rules by the SEC in October, 2015, expanded equity crowdfunding opportunities for non-accredited investors. That means investors who earn less than $100,000 per year or have less than $100,000 in net worth can invest up to the lesser of $5,000 or 5% of their annual income or net worth. Those with annual earnings or net worth between $100,000 and $200,000 can invest the lesser of $10,000 or 10% of their annual income.
Here are a just a few of the many crowdfunding success stories.
- Reading Rainbow. In the spring of 2914, LeVar Burton’s Kickstarter campaign aimed at bringing Reading Rainbow, the educational TV show loved by children of the ‘80s and ‘90s, into the digital generation blew past its initial $1 million goal, collecting a total of $5.4 million and raising money from more than 105,000 people.
- All-in-One Travel Jacket. Hiral Sanghavi and his wife Yoganshi Shah launched a Kickstarter campaign to fund the production of the all-in-one travel jacket they invented together. Their goal was $20,000. To date, they have raised more than $10.6 million.
- FORM1, a project to create an affordable, professional 3D printer for the public blew through its original $100,000 goal, getting over 2,000 backers and $3 million dollars in funding.
- Veronica Mars Movie. The movie was one of the fifth highest grossing crowdfunding projects to date, aiming for $2 million in funding, and ending up with over $5.7 million. Scanadu Scout. The Scout is the first medical tricorder packed with sensors designed to read vital signs and wirelessly send them to a smartphone to diagnose symptoms in seconds set out to raise $100,000 and ended up with over $1.5 million in funding. http://www.entrepreneur.com/article/232234
- Presidential campaign. And, you may remember, President Barack Obama’s campaign used “advanced crowdfunding” in the 2008 presidential election, raising $750 million in small contributions, then again four years later raising $214 million in small donations.
Are crowdsourcing sites one size fits all?
No they’re not. As of 2012, there were over 450 crowdfunding platforms, so you’ve got your research work cut out for you in order to select the one that best fits your business. As you’d likely expect, all sites are not created equal. Some specialize in nonprofits, or in certain types of products or services; others offer consulting services in addition to sourcing funding. While many platforms accept different types of projects and differentiate themselves by genre, certain crowdfunding sites have emerged as experts in their specific field.
For instance, Onevest (formerly RockThePost) focuses on entrepreneurs and small businesses but shies away from community projects. GreenUnite hosts eco-friendly and sustainable projects in any genre, connecting earth-conscious individuals and corporations. Kickstarter is your go-to if your project fits into the arts and creative space, and Indiegogo is a good option if you want a broad, non-focused platform.
AngelList brands itself as a platform for startups, CircleUp focuses on consumer product and retail startups, Fundable allows entrepreneurs to raise money from investors, customers and friends, MicroVentures helps companies in the software, mobile, media and entertainment, social, gaming and green-tech industries, including Facebook, Peerbackers focuses on funding entrepreneurs and innovators and RealtyShares concentrates on real estate ventures.
Is crowdsourcing a good option for you? Maybe…
At the present time, the crowdfunding movement appears unstoppable. According to a recent report by research firm Massolution, crowdfunding raised $16 billion in 2014, was expected to raise $34 billion in 2015, and is poised to revolutionize the way companies are funded while at the same time disrupting traditional private equity, banking and venture capital industries.
But is it right for your business?
Be sure not to miss our next post (Is crowdfunding a viable option for financing your small business startup? Part two) where we take a closer look at the most popular crowdsourcing platforms, check out the relevant government regulations plus discuss some other aspects of crowdsourcing finance that you may want to consider before jumping in.
Share your own experiences with crowdsourcing, or just tell us your thoughts on this alternative finance method by commenting below. And once you’ve run your successful crowdfunding campaign, and your business is off the ground, consider invoice factoring to solve any cash flow issues you may have.