The Pros and Cons of Crowdfunding: Is It Right for Your Business?Article originally posted on www.erieinsurance.com(opens in new tab)
As a business owner, you’re undoubtedly familiar with the old adage, “it takes money to make money.” It’s a fact that rings true for any new venture. Whether you’re looking to launch a startup, expand your existing service offering or add a second location, it requires an upfront financial investment.
Traditionally, most entrepreneurs have had only a few options for funding their business. They can self-fund their efforts out of their own pocket, raise money from investors or turn to a bank for a small business loan.
But over the past decade, the rapid growth of the internet and social media has paved the way for a new way to raise capital: crowdfunding.
You’ve likely heard stories of successful companies that got their start on popular crowdfunding platforms like Kickstarter or Indiegogo. But is crowdfunding the right fundraising choice for your business? Read on to find out.
What is Crowdfunding?
As its name suggests, crowdfunding involves raising money from a large group of people – called crowdfunders. Unlike a traditional investor, each crowdfunder typically makes a small investment in your business. But when all those contributions are combined, they can add up to a sizable amount of capital.
According to the crowdfunding site Fundly, about $34 billion was raised through crowdfunding platforms globally in 2020. And that number is predicted to triple by 2025!
What Types of Crowdfunding Are Available for Businesses?
While the basic definition of crowdfunding can be applied across the board, crowdfunding platforms differ on how their deals are structured. If you’re considering a crowdfunding campaign for your business, there are four basic types to consider.
- Debt crowdfunding. This type of crowdfunding functions like a traditional business loan. Your campaign will raise money from individuals, with the expectation that you’ll pay back their investment. Some nonprofit funding platforms, like Kiva, focus on providing interest-free loans for worthy causes. Other debt crowdfunding platforms, also called peer-to-peer lending sites, require you to pay back crowdfunders based on a set repayment schedule and interest rate.
- Equity crowdfunding. If you’re looking for a cash investment that doesn’t need to be repaid, equity crowdfunding may be for you. These types of crowdfunding platforms let individuals invest in your business in exchange for an equity stake in your company. Think of it like a small-scale angel investor or venture capitalist. You set the terms of the deal, and the investment doesn’t need to be paid back like a loan.
- Reward-based crowdfunding. Made popular by companies like Kickstarter, reward-based crowdfunding doesn’t require you to pay back an investment or give up an equity stake. Instead, your crowdfunders will receive some type of benefit in exchange for investing in your campaign. It could be early access to your new product or adding their name to the credits of your new documentary. The rewards and corresponding investment levels are up to you.
- Donor crowdfunding. This type of crowdfunding platform requires you to give nothing in return for a contribution – crowdfunders are simply donating to support your cause. Made popular by platforms like GoFundMe, these types of crowdfunding campaigns typically cater to nonprofits or individuals and businesses facing some type of financial hardship.
What Are the Advantages of Crowdfunding?
- Easy access to capital. Compared to applying for a small business loan or seeking out an individual investor, the barriers to launch a crowdfunding campaign are relatively low. You don’t need a high credit score or an airtight business plan to launch a campaign. You just have to convince others to back your idea.
- Lower interest rates. Depending on the type of crowdfunding platform you choose, you may pay considerably less in interest compared to a traditional bank loan. You could even end up with an investment that doesn’t need to be repaid at all.
- Added publicity. The most successful crowdfunding campaigns are those that generate avid support from their investors. If crowdfunders believe in your cause, they’ll be likely to share your campaign with friends and family – increasing awareness of your business, generating free word-of-mouth promotion and attracting additional investors.
- Low risk. Starting a crowdfunding campaign can be an easy way to gauge the level of support or interest in your new business idea. Because the upfront investment is minimal, there’s no real risk if your campaign flops.
What Are the Disadvantages of Crowdfunding?
- Failed campaigns. Not every crowdfunding effort is successful. In fact, according to The Crowdfunding Center, only 22.4% of crowdfunding campaigns actually reach their investment goals. Depending on the platform you choose, that means you could walk away with nothing.
- Competition. With the growing popularity of crowdfunding campaigns, it’s harder than ever to stand out from the crowd. To launch a successful campaign, you’ll likely need to spend a significant amount of time marketing and promoting your fundraising efforts.
- Fees. While crowdfunding can be a great alternative to more traditional financing options, there’s no such thing as “free money.” Nearly every crowdfunding platform will take a cut of your investment for the use of its services. And you may also have to pay processing fees for donations made using credit cards.
- Tight timelines. Most crowdfunding platforms only give you a limited amount of time to fund your campaign. If you don’t generate enough interest in that time period, you could be left without an investment.
What Should I Know Before Starting a Crowdfunding Campaign?
- Choose the right platform. Because crowdfunding options are so diverse, it can be difficult to give specific advice on the types of projects or initiatives that are a good fit. But regardless of your project, it’s important to pick a platform that aligns with your needs. For example, if you’ve got a great idea for a new business startup, debt or equity crowdfunding platforms may be your best option. Looking to launch a new product? Reward-based crowdfunding can help you earn initial sales along with your upfront investment. Once you narrow down the crowdfunding category, do your research on the platforms that are available. Compare and contrast their services, requirements, reputation and fees. And be sure to check out examples of past success stories. Doing your homework in advance can help increase your chances of crowdfunding success.
- Invest in marketing. To raise an investment through crowdfunding, you’ll need to share your story in an effective and compelling manner. Don’t underestimate the importance of having high quality photos, videos and related content before your campaign launches. If you’re not a marketer at heart, you may want to consider hiring some outside marketing expertise to help you tell your story.
- Protect your intellectual property. If you have an idea for a brand new product or service, promoting it publicly on a crowdfunding platform could allow someone to steal your idea. And if they can bring it to market faster than you, it might take a lengthy (and expensive) legal battle to make things right. If protecting your intellectual property is a concern, it may be worth checking into your options for securing patents, copyrights or trademarks first.
- Use your social network. The success of your crowdfunding campaign will depend, in large part, on your ability to spread the word. Be sure to lean into your personal and professional networks – both in person and on social media platforms. And don’t be afraid to ask your friends and family to share your campaign to help you reach your goals.
- Know the tax implications. Before you launch your crowdfunding campaign, it’s important to understand how any contributions may impact your year-end tax bill. As far as the IRS is concerned, the money you earn from crowdfunding will generally be taxed as income during the year you receive it. This is especially true if crowdfunders have received anything in return for their contribution. Of course, the tax implications for your exact situation may vary – so it’s best to get counsel from an attorney, accountant or tax professional.
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