As a business owner, you’re no doubt familiar with the old adage, “it takes money to make money.” It is a fact that applies to all new ventures. Whether you’re looking to start a business, expand your existing service offerings, or add a second location, it requires an upfront investment.
Traditionally, most entrepreneurs have had only a few options to finance their business. They can self-fund their efforts out of pocket, raise money from investors, or turn to a bank for a small business loan.
But over the last decade, the rapid growth of the internet and social media has paved the way for a new way to raise capital: crowdfunding.
You’ve probably heard stories of successful businesses that started 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 the name suggests, crowdfunding means collecting money from a large group of people – called crowdfunders. Unlike a traditional investor, each crowdfunder usually makes a small investment in your business. But when all these contributions are combined, they can add up to a substantial amount of capital.
According to crowdfunding site Fundly, around $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 in how their deals are structured. If you are considering a crowdfunding campaign for your business, there are four basic types to consider.
- Debt crowdfunding. This type of crowdfunding works like a traditional business loan. Your campaign will raise money from individuals, with the expectation that you will repay 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 repay crowdfunders based on a set repayment schedule and interest rate.
- Crowdfunding with shares. If you’re looking for a cash investment that doesn’t need to be repaid, equity crowdfunding might be for you. These types of crowdfunding platforms allow individuals to invest in your company in exchange for an equity stake in your company. Think of it as a small-scale angel investor or venture capitalist. You set the terms of the deal, and the investment does not have to be repaid like a loan.
- Reward-based crowdfunding. Made popular by companies like Kickstarter, rewards-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 simply donate to support your cause. Made popular by platforms like GoFundMe, these types of crowdfunding campaigns are usually aimed at non-profit organizations 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 an individual investor, the hurdles to launching a crowdfunding campaign are relatively low. You don’t need a high credit rating or an airtight business plan to launch a campaign. You just have to convince others to support your idea.
- Lower interest rates. Depending on the type of crowdfunding platform you choose, you can pay significantly less in interest compared to a traditional bank loan. You may 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 enthusiastic support from their investors. If crowdfunders believe in your cause, they are likely to share your campaign with friends and family – raising awareness of your business, generating free word of mouth and attracting additional investors.
- Low risk. Starting a crowdfunding campaign can be an easy way to gauge the level of support or interest for your new business idea. Since the upfront investment is minimal, there is no real risk if your campaign fails.
What are the disadvantages of Crowdfunding?
- Failed campaigns. Not every crowdfunding effort is successful. According to The Crowdfunding Center, only 22.4% of crowdfunding campaigns actually reach their investment goals. Depending on the platform you choose, this 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 will likely need to spend a lot of time marketing and promoting your fundraisers.
- Charges. While crowdfunding can be a great alternative to more traditional funding options, there is no such thing as “free money.” Almost every crowdfunding platform will take a cut of your investment for the use of their services. And you may also have to pay processing fees for donations made by credit card.
- Tight timelines. Most crowdfunding platforms only give you a limited amount of time to fund your campaign. If you don’t generate enough interest during that time period, you could be 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 what types of projects or initiatives are a good fit. But regardless of your project, it’s important to choose a platform that fits your needs. For example, if you have a great idea to start a new business, debt or equity crowdfunding platforms may be your best option. Do you want to launch a new product? Reward-based crowdfunding can help you earn initial sales along with your upfront investment. Once you’ve narrowed down the crowdfunding category, do your research on the platforms available. Compare and contrast their services, requirements, reputation and fees. And be sure to check out examples of past success stories. Doing your homework ahead of time can help increase your chances of crowdfunding success.
- Invest in marketing. To raise an investment through crowdfunding, you need to share your story effectively and convincingly. Don’t underestimate the importance of having high-quality images, videos and related content before your campaign is launched. If you’re not a marketer at heart, you might want to consider hiring an outside marketing expert to help you tell your story.
- Protect your intellectual property. If you have an idea for a brand new product or service, marketing it publicly on a crowdfunding platform could allow someone to steal your idea. And if they can get it to market faster than you, it could take a long (and expensive) legal battle to make things right. If protecting your intellectual property is a concern, it may be worth checking out your options for securing patents, copyrights or trademarks first.
- Use your social network. The success of your crowdfunding campaign will largely depend 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 consequences. Before starting your crowdfunding campaign, it’s important to understand how any contributions may affect your year-end tax bill. As far as the IRS is concerned, the money you earn from crowdfunding will generally be taxed as income in the year you receive it. This is especially true if crowdfunders have received something in return for their contribution. Of course, the tax consequences for your exact situation may vary – so it’s best to get advice from a lawyer, accountant or tax expert.
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