How Does Crowdfunding Work: Guide for Small Businesses
Startup investment overtook crowdfunding in recent years. But for most small businesses, crowdfunding is still a great option. Here’s why!
There was a time during the early 2010s when crowdfunding was all the rage. Before GoFundMes became linked to personal tragedies, crowdfunding startups prioritized new businesses. It was meant to be the answer to strict, stuffy banks and their business loans.
Small business loans are still so hard to come by, and yet crowdfunding is overlooked. I want to posit that this form of funding is an incredible opportunity.
Allow me to make a case for crowdfunding. We’ll discuss how it works and why it may be the best way to fund your small business.
Here’s What We’ll Cover:
What is Crowdfunding?
Crowdfunding is simply a way of raising money from a large number of people. Instead of appealing to individual investors, you are marketing to the masses. Crowdfunding sites enable that process by hosting and publicizing your campaign.
Now. Notice I didn’t say anything about donations. Only one type of crowdfunding involves donations. Here are the three main types of crowdfunding.
1. Donation-Based Crowdfunding
This is the model Kickstarter and Indiegogo follow. Donations from patrons can come with some kind of reward too. This is called reward-based crowdfunding. For example, Kickstarter is a common place to launch indie board games. The project gets funded and the first backers get to receive the product before the rest of the market does.
2. Debt Crowdfunding
This is more commonly referred to as peer-to-peer lending. The platform you have probably heard of is Lending Club. With debt crowdfunding, citizens from across the world can invest in your business. Remember that this is a loan. You will need to pay the money back with some interest. It is still cheaper in terms of interest rates. You’re also far more likely to secure a peer lending loan than a traditional small business loan from a bank.
3. Equity Crowdfunding
Equity-based crowdfunding funding is similar to startup funding. The group invests in your business in exchange for stock in your company. You then pay dividends to your new investors. These investors can also have a say in the direction of the company.
What Are the Benefits of Crowdfunding?
- The Exposure Is Amazing
The amount of buzz you create with crowdfunding is second-to-none. If you create a successful campaign, you can get folks really excited for your launch. This is particularly true for product launches.
- Building Strong Consumer Relationships
Your investors or donors will likely be die-hard fans of your concept. Getting them involved in the creation of your product or service makes them feel a sense of pride and ownership. This serves you well for customer loyalty. They will buy from you for now and forever!
- A Successful Crowdfunding Campaign Looks Good
If you intend to seek VC investment or even traditional bank loans at a later date, your crowdfunding success could help. Crowdfunding shows that you already have a fanbase and customers. Your brand name is out there. These are all good signs for future potential investors.
- You Can Raise a Lot of Money
We have all heard the stories of crowdfunding campaigns asking for $5000 and reaching $5million in just a couple of weeks. This is definitely a unicorn situation. That said, the ceiling is somewhat limitless when it comes to crowdfunding because anyone can give any amount of money. Though the aim is not to make a financial return in the traditional sense, you may end up with more than you bargained for.
What Are the Drawbacks of Crowdfunding?
- Crowdfunding Campaigns Take a Lot of Effort
Even if you do for the donation model, crowd funders need nurturing. You are essentially building a little community to support your new venture. Your funders will be expecting frequent updates and promises fulfilled. This can be a lot of pressure - especially if you are a new entrepreneur.
The promo aspect is also taxing. Great branding and marketing are what make a crowdfunding campaign successful. Can you stomach it?
- Success Is Not Guaranteed
Your crowdfunding campaign could flop. I’m just going to say it. Just as it could be a runaway success, it could be an abject failure. With some platforms you will need to return all the money raised if you don’t hit your fundraising goal.
- Equity Crowdfunding Is Complicated...sometimes
You now have thousands of investors. In theory, that is great, but you didn’t choose them. Any person can now have part equity in your company and therefore be owed dividends.
How to Start a Crowdfunding Campaign
The components of a good crowdfunding campaign are simple:
- Business Idea
What’s the big idea? Can you communicate it in an elegant elevator pitch?
Why should anyone invest in your business?
- Founding Team
Why are you the team to execute this particular vision? What credentials do you bring to the table?
- Crowdfunding Type
Which crowdfunding category works best for your business goals? If it is a B2B business, peer-to-peer lending may work best. For B2C companies, donation-based crowdfunding is most popular. Equity crowdfunding works for both.
You’ll need to choose a crowdfunding platform to host your campaign. Look into their fees, terms and conditions. What happens to the money if you don't hit your funding goal? The fine print is particularly important when you are raising a large amount of money. Speaking of which…
- How Much?
How much money are you raising? Can you clearly explain where these funds are going? Do you have a business plan of milestones for the launch of your product or service?
- Marketing Campaigns
Marketing is incredibly important when it comes to crowdfunding. It can sink or save your campaign. The platform can help share your project as much as possible. But bear in mind that the larger platforms host hundreds of campaigns at a time. They can’t devote much space to publicizing your specific project.
The art of crowdfunding is 80% marketing. Maybe even 90%.
Get your branding beautifully designed. Think of how to best advertise the incentives. Show behind-the-scenes footage of the product. Post a video with the business owners talking about their vision. Whatever you need to do to make your crowdfunding campaign stand out among the thousands of others on the internet.
Is Crowdfunding for You?
Crowdfunding for you if:
- You are at the beginning of your business journey. This is called a seed or pre-seed funding round.
- You are producing products that need funds to create
- You need to raise money quickly to begin the venture
- You have the time to optimize your marketing channels to ensure success
- You can afford a sizeable marketing budget
- You have a clear value proposition that you can communicate to non-industry experts
I hope I have made a good case for crowdfunding! For B2C businesses, it can be a fantastic launchpad. You have a community of super fans right from the beginning.
We have written more articles and guides about small business funding over on our resource hub. See you there!