Friends, Family, Strangers: The Dos and Don’ts of Crowdfunding Your Small Business

Virtually unheard of a few years ago, crowdfunding has boomed in the past few years. By definition, crowdfunding is “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the internet.”

You’ve probably engaged in crowdfunding yourself, perhaps by helping an author self-publish a book or an inventor get the capital needed to launch an interesting product to market. Maybe you donated through a platform like GoFundMe to help a local family or nonprofit organization in need.

From its humble beginnings, crowdfunding has grown past quirky projects and pleas for donations. According to a recent report by crowdfunding and crowdsourcing research company Massolution, within the next few years, crowdfunding will surpass venture capital as the leading source of small business startup funding.

There are thousands of crowdfunding platforms, including Indiegogo, RocketHub, Peerbackers and Kickstarter. It’s no surprise that crowdfunding has become an attractive alternative to traditional small business funding. It’s fast—you usually don’t have to give up control of your business to one person or entity—and it often requires less hoop-jumping than obtaining financing through small business lending. But is it right for you? Before you start a campaign, make sure you know the dos and don’ts of crowdfunding for small business.

Saying ‘Yes’ to Crowdfunding? Here’s What You Should Do

Read the fine print. All crowdfunding is not created equal. For several years, it was possible to raise money for a project just by making a pitch for money, taking what you got and giving your contributors a product or a thank-you in return. Starting this year, thanks to Title III of the JOBS Act, small businesses can raise capital via crowdfunding, giving contributors stock in the company in exchange for their contribution. Before you start a campaign, consider what you are willing to give up in exchange for contributions.

Crowdfunding platforms fall into three categories:

  • Equity-Based Crowdfunding: The supporter or investor receives shares of the company in exchange for money pledged. Essentially, you give up an ownership stake.
  • Reward-Based Crowdfunding: Supporters donate to a project in exchange for tangible, non-monetary rewards, such as getting their name on your website, a finished product, a t-shirt or something as simple as a thank-you note.
  • Debt-Based Crowdfunding (Peer-to-Peer Lending): Asks donors to lend you money. In return, you promise to pay them an agreed-upon interest rate.

Know if it’s all or nothing. Some crowdfunding platforms, such as Kickstarter, use an all-or-nothing funding model. If you set a goal to raise $25,000 and your campaign raises only $24,500, your donors are not charged for their pledge and you receive nothing. Why is this important? Because less than a third of crowdfunding campaigns reach their goal.

If your pie-in-the-sky dream is to raise $50,000, but you’ll happily settle for whatever you can get, make sure you choose a platform that has a flexible-funding option, like Indiegogo, so no matter what percentage of your fundraising goal is reached, you’ll still get the money.

Get family and friends involved. Borrowing from friends and family to start a business is always a risky, sometimes awkward, proposition. If your venture goes belly-up, you could damage an important personal relationship. Yet according to the crowdfunding site Fundable friends and family are still one of the major funding sources for all entrepreneurs, investing over $60 billion in startups in 2014.

That’s where crowdfunding can make borrowing from friends and family a little less stressful. If you choose debt-based crowdfunding, borrowing from mom and dad’s bank account can help you structure the loan. You’ll be able to treat it more like a business transaction and provide some reassurance that you will repay the loan on time.

Keep it simple. Whichever fundraising model you choose, you’ll need to get buy-in from your audience. To get that buy-in, keep your message simple. Potential investors may have trouble connecting with complex concepts. Think about the problem your product or service solves, then explain your solution. Explain how the money you raise will help you take your business to the next level. Keep your pitch short and concise, and make sure you include a call-to-action.

But Ensure You Don’t Do This

Don’t try to set up your own crowdfunding portal. When Title III of the JOBS Act made equity crowdfunding accessible to the general public, it also established regulations to ensure that crowdfunding portals comply with federal securities laws and Financial Industry Regulatory Authority rules. Crowdfunding portals must register with the Securities & Exchange Committee (SEC), a complex and expensive process. Save yourself the headache and expense and stick with one of the many reputable platforms that already exist.

Don’t ask for money unless you’ve got skin in the game. The best way to show that you believe in your business is to put some of your own money in. Why would a stranger risk their hard-earned cash on your dream if you’re not willing to risk some of your own?

What Happens when Crowdfunding Goes Wrong?

If your fundraising goals are really big, you may not be able to raise all of the money you need through crowdfunding. You can raise up to $1 million in capital per year through equity crowdfunding without having to register with the SEC. If you need more than that, you may have to seek out the rest from angel investors, venture capitalists or traditional small business loans.

Also, keep in mind that crowdfunding platforms are in business to make money. Expect to pay around five to 10% in fees, which will reduce the amount of capital you’ll have available for the business. Consider those fees as you set your fundraising goals.

How to Start Your First Campaign

1. Have a plan. A successful crowdfunding campaign is more than just a description of what you plan to do with the money. Tell your story. Explain how your product or service will solve an issue that people can connect with. Demonstrate that you know your stuff and show potential investors that their investment in you will pay off.

2. Get your accounting records in order. Part of Title III of the JOBS Act requires that entrepreneurs disclose certain financial information to investors. Depending on how much you plan to raise, you may need to have your financial statements reviewed or audited by an accountant. Even if the amount you intend to raise is modest, having good accounting records shows credibility. It’s a sign that you take your business seriously and make the effort to do things the right way.

3. Identify the crowdfunding site(s) for you. There is no one perfect crowdfunding platform for everyone, since anyone seeking to raise money to start a business has different goals and priorities. A good way to make your decision is to set up a spreadsheet to compare the various platforms. Compare available tools, fees, what you’re giving up in exchange for funding, and whether the platform is goal-based or flexible.

Whatever platform you choose, be prepared to do a lot of work, even after the campaign has launched. You will need to continuously promote your campaign and encourage friends and family to do the same. You’ll also need to be available to communicate with backers and field questions about your business. If you do it right, a well-run campaign can reap rewards long after the fundraising period is over. You’ll have created an avid customer base that will continue to support and promote your business.

about the author

Freelance Contributor Janet Berry-Johnson is a CPA and a freelance writer with a background in accounting and insurance. Her writing has appeared in Forbes, Parachute by Mapquest, Capitalist Review, Guyvorce, BonBon Break and Kard Talk. Janet lives in Arizona with her husband and son and their rescue dog, Dexter. Outside of work and family time, she enjoys cooking, reading historical fiction and binge-watching Real Housewives.