How to Fund Your Startup Business Using Crowdfunding
- April 30, 2020
- Starting Your Business
- 12 min read
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In the gig economy, you can crowdsource almost anything. From formal crowdsourcing, which often involves droves of freelancers doing data, writing or design work, to informal crowdsourcing, which might involve someone asking for recommendations or information on Facebook, millions of people reach out to one another on a daily basis to crowdsource information and money.
You can do the same if you need funding to get your new business idea off the ground. Using crowdfunding to acquire capital to launch startup companies has become very popular in recent years. As this method of funding matured, more and more options have emerged. Read on to find out how to fund your startup business using crowdfunding.
What Does Crowdfunding Your Startup Mean?
Crowdfunding literally means turning to a crowd of people and asking them to provide financial support to fund your new business. For instance, you could put the call out on social media or email or even regular mail, to many of your acquaintances, asking everyone to pitch in $200 to fund your startup. Alternatively, the method that has become especially popular is that you use a platform such as Kickstarter to connect with thousands of people online who can contribute any amount, big or small.
How you crowdfund, and the scope of the crowd you seek, depends on your goals, your financial needs and what you have to offer your donors. Your method of crowdfunding can also depend on whether your business offers products versus services. Some crowdfunding platforms work better for service-based startups and others are better for product-based startups. Ultimately, the way you market your idea and get people to believe in it is among the most crucial factors.
Crowdfunding Models for a Business
The basic models for crowdfunding platforms fall into certain categories. The major models are donation-based, rewards-based, lending-based, pre-sales-based models and equity-based. Each one of these models has shared features but also key differences. Here’s a look at the major forms of crowdfunding:
- Donation-Based Crowdfunding: This is the most basic and straightforward method of crowdfunding a project. It works based on philanthropy and knowing that donors’ money goes toward a good cause. Pure donation-based crowdfunding is mostly associated with charitable projects through platforms like GoFundMe, but they can be business projects as well.
- Rewards-Based Crowdfunding: This model works by supporters choosing the size of their contribution and then receive special perks in return, based on the concept that more money contributed means the greater reward. For the investors, the process works more like making a purchase, though they understand their goods may not arrive for quite some time.
- Pre-Sales-Based Crowdfunding: Similar to the rewards-based model, contributors receive the finished product in exchange for the money they give. However, unlike the rewards-based model, there is a fixed price based on market value and production costs, rather than the contribution size being determined by the investor. Thus, to do this type of crowdfunding, you’ll need to do some thorough homework to determine market value and costs before you can accept contributions.
- Lending-Based Crowdfunding: Also called a debt-based model, this includes what is classified as peer-to-peer lending. With P2P lending, the crowd can fund multiple microloans based on a specific set of terms. Debt models may also come with other agreements, such as a timeline on when the company or product will be launched. If the timeline isn’t met, you may have to pay back the funds. One thing to note about peer-to-peer loans is that they’re not contract-based like standard loans, so the legal guarantees are a little difficult to secure.
- Equity-Based Crowdfunding: Also called investment-based crowdfunding, this model allows for interested parties to get equity in the companies they contribute to. Investors know they won’t receive any return unless the business sees a profit or you sell it. Equity models typically contain rules on what power investors might have and how their ownership of the business will be handled. Crowdfunding via equity isn’t the same thing as going public with a corporation, though.
A key point here is that, like with so many other things, there’s no one right answer. Each method of crowdfunding has its own advantages and disadvantages. The right crowdfunding fit for your business is naturally heavily dependent on your company, your proposed project, service or product and your funding goals.
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How to Choose the Right Crowdfunding Platform for Your Startup
To choose the right option you need goals and plans. The rewards model works well if you have an interesting product idea people can get excited about and share with others. The debt and equity models may work better for business ideas that are solid and offer a good chance of return but aren’t as exciting for the consumer.
Some crowdfunding sites you can use include:
- Kickstarter: The king of rewards-based crowdfunding; you’ll have to meet your fundraising goal before you receive funds
- Indiegogo: Rewards-based crowdfunding for unique or innovative ideas
- Fundable: Investors and private citizens funding business ideas
- Crowdfunder: Connects entrepreneurs with equity investors
- Patreon: Subscription-based crowdfunding that works for writers, artists and publishers
There are more crowdfunding platforms out there, so you should do your homework beyond just these. Always remember that, despite many similarities, each platform has its own rules and stipulations. Some allow you to miss your funding goal but take whatever you’ve amassed. Other platforms, if you miss your goal, don’t allow you to keep any money. Thus, read the fine print with every platform you investigate.
What Are the Benefits of Crowdfunding Your Business?
Crowdfunding has numerous benefits. First, you don’t need a credit history or even good credit. You don’t need a traditional business plan and all the due diligence required by banks. You also don’t need to fulfill requirements like time in existence as a business and amount of revenue generated, though these could certainly entice more contributions if your company already clearly has potential.
In fact, all you really need is a business idea, product or service that resonates with the crowd along with the marketing chops, or access to someone who has them, to get noticed online or in the community. The entire concept of crowdfunding is that you connect with people who are excited about your business, so they open their wallets to help fund it. For example, if you’re trying to open a sandwich shop in an area that has no restaurants, residents might back you simply because they love the idea of convenient lunch or dinner options in the area. The right levels of excitement and a little luck online can help you go viral with your crowdfunding campaign, putting your idea in front of potentially millions of micro-investors and consumers.
Crowdfunding can also help you access funding quickly. Depending on how you crowdfund and which platform you use, you can gain access to funds within days or weeks. This isn’t true of every program, so you must read the fine print before you commit to any crowdfunding campaign.
Read: SBA Loan Rates
What Are the Disadvantages of Crowdfunding Your Startup?
One of the biggest disadvantages of crowdfunding is what makes it so popular with the investors: You have to offer something of value in return, and then, you must follow through on those promises. This isn’t really a disadvantage compared to other business loan options. You’re always going to have to pay something back in some way. But with crowdfunding, you can become locked into the agreement you’ll need to uphold.
If you fund your startup with a loan or business credit card, you simply have to make monetary payments according to your agreement. How you manage your cash flow to make those payments is up to you. In crowdfunding, you may agree to provide specific products or services to investors by specific dates, which leaves you less wiggle room if things don’t go as planned.
Going through a crowdfunding platform like Kickstarter or Indiegogo may make it possible to get seen by the masses, but you’ll also likely pay for the exposure. Many of these platforms have fee structures, so always read the fine print so you understand what portion of your funding may go toward those expenses.
The Bottom Line
Crowdfunding can be an exciting, lucrative way to fund your startup or new product idea, but these opportunities often come with a lot of fine print. Take your time, understand all the requirements and ensure you can back up your promises with realities before you plunge into the crowdfunding pool.
If crowdfunding doesn’t make sense for your business, don’t get distraught. Even if you can’t get a traditional SBA loan or term business loan from a bank, there are many alternative ways to fund your startup besides crowdfunding, such as using personal and business credit cards to fund your startup.
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Photo credit: aradaphotography/Shutterstock.com
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