Crowdfunding for Small Businesses Pt. 1: Is Crowdfunding a Viable Option for Small Businesses?
After Eric Migicovsky failed to receive necessary funding from investors he turned to crowdfunding. The 25-year-old founder of Pebble launched a crowdfunding campaign on Kickstarter, the world’s largest crowdfunding platform, on April 11, 2012 with a funding goal of $100,000 to create 1,000 smartphone-synced watches. Backers would receive a Pebble watch as a reward if they donated at least $99. In the first 28 hours Pebble received $1 million in donations. After five weeks over 68,900 backers had contributed, bringing the total to $10.3 million and Migicovsky had to ask people to stop donating.
Pebble, and similar success stories, have been used to support claims that crowdfunding is the best thing to happen to small business since Apple’s App Store. However, as critics point out, crowdfunding is stressful, competitive, and doesn’t always work. In this article you will learn:
- What crowdfunding is
- How the JOBS Act will change crowdfunding in the U.S.
- The pros and cons of crowdfunding vs. traditional financing
What is Crowdfunding?
Crowdfunding (sometimes called crowd financing or crowd sourced capital) is the process of asking the general public to provide startup capital for new ventures. Campaigns typically run on popular crowdfunding websites for 30 to 90 days.
There are four main types of crowdfunding:
- Equity-Based Crowdfunding: Investors receive a stake in the company.
- Lending-Based Crowdfunding: Investors are repaid over a period of time.
- Donation-Based Crowdfunding: Contributions go towards a charitable cause.
- Reward-Based Crowdfunding: Donors receive tangible, non-monetary rewards such as a watch or a pre-released CD.
Existing laws have limited crowdfunding in the United States to the reward-and donation-based crowdfunding models only. Therefore, U.S. donors could not receive any form of ownership or monetary compensation for their contribution. Without any potential for return on investment, it’s no surprise that the most common amount donated to projects on Kickstarter is only $25. Compare that to an average investment of $2,900 on the U.K site crowdcube.com where equity-and lending-based crowdfunding is allowed.
However, the recent passage of the JOBS Act (which goes into effect January 1, 2013), will allow U.S. small business owners and investors to participate in equity-and lending-based crowdfunding, also known as “business crowdfunding.”
If you are considering using crowdfunding for your next business venture, here are some pros and cons to consider:
- You retain complete ownership of the entire business and project.
- You control the decision-making processes (not the case with traditional investors).
- You can gauge public interest before spending money on new services or products.
- There is the potential to exceed your funding goal, as Pebble did ($100,000 goal yet funded $10.3 million).
- You can begin receiving pledges as soon as you make a plan and create a compelling pitch.
- After you build an audience you can propose future projects to them.
- Backers can give valuable feedback, not only funds, about your project.
- Managing a crowdfunding campaign takes a significant amount of time.
- Without a pre-existing audience it can be difficult to get funding.
- You must convince thousands of people with a pitch, as opposed to one or two investors.
- Competitors could steal your ideas since they’re published publicly.
- It requires much more creativity to create a compelling pitch and idea.
- You could end up spending a lot of time and effort and still not reach your funding goal.
- Crowdfunding is becoming more and more competitive.
- You miss out on expert advice you typically get from experienced investors.
How To Choose Between Crowdfunding and Traditional Financing
Crowdfunding isn’t right for every business. While it’s ideal for startups with a strong consumer focus, it can be difficult for B2B ventures or technical projects. Success in crowdfunding hinges on a short compelling pitch that resonates with a large group of everyday people. So if you’re selling a new customer relationship management system to insurance agencies, crowdfunding is probably not right for you.
The other factor to consider when deciding between crowdfunding and traditional financing is how much capital you need. Crowdfunding is best suited for businesses that need to raise under $100,000. Keep in mind that Pebble is the most funded crowdfunding campaign in history and is the exception, not the rule.
If you decide crowdfunding is right for you, you will need to decide between the donation/reward or equity/lending methods. The donation/reward method is better if you’re targeting people who will donate for altruistic reasons, while the equity/lending method tends to attract people who want to invest for profit.
Once you have decided if crowdfunding is right for your venture, you need to create a compelling crowdfunding pitch. See, Crowdfunding for Small Businesses Pt. 2: How to Craft a Compelling Crowdfunding Pitch.
Joshua Monen is a freelance financial writer, marketing consultant and speaker who specializes in small business, personal finance and startups. His has written for numerous national publications and websites including PerkStreet, MicroVentures and Lanier Upshaw.
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