Crowdfunding is rapidly gaining popularity as the preferred type of alternative business funding for start-ups and small businesses to fund their ventures. It's popular as it removes the need to pitch the business to panels of investors, it can create valuable interest in a start-up before launch and it allows a founder to assess the demand for their product or services.
Crowdfunding is the collective effort of a group of individuals who pool small amounts of money to support a new business venture or a project. The fundraising is usually organised over online platforms or social media, with a growing number of crowdfunding websites enabling small businesses to raise money in exchange for rewards, equity in the company, or future repayment.
There are three main types of crowdfunding for business, based on equity, debt and reward.
With equity crowdfunding businesses sell a share of their company to a group of investors, a model ideally suited to businesses that can scale quickly.
Debt crowdfunding works in a similar way to a traditional business loan. Funds are raised at a predetermined annual percentage rate (APR), but instead of owing the bank, the borrower owes payment to the individual backers. The redistribution of funds, from borrower to lenders, is usually handled by an intermediary – most often a crowdfunding platform. This is often the model of choice for businesses with strong revenues and credit histories.
With reward crowdfunding, backers receive a small gift or product sample in return for pledging a certain amount of cash – think most Kickstarter projects. For the business owner it avoids the need to repay debt or part with equity, and is often used by businesses with a product that can be shipped, or that need funding before generating revenues.
There are hundreds of financial crowdsourcing sites globally and their numbers are growing, however some of the best known and well established platforms are the most popular with small business owners seeking funding.
Kickstarter has produced some massive hits, including the famous Pebble smartwatch. With its ‘all-or-nothing’ model, business owners set a funding goal, but must forfeit any funds raised if the target isn’t met. If a project is successfully funded, Kickstarter applies a 5% fee to the funds collected for creators, plus payment processing fees. Campaign times can be set anywhere between one and 60 days, but the site recommends a period of 30 days.
Targeted more at entrepreneurs than its closest rival Kickstarter, Indiegogo’s crowdsourcing platform includes three categories: tech and innovation, creative projects and community projects. It charges a 5% platform fee across all crowdfunding campaigns, plus additional payment processing fees. Indiegogo also offers flexible funding, which means founders get to keep the funds they raised, even if they didn’t reach their goal.
Lending Club offers crowdfunding for small business via business loans of up to $300,000 with a fixed term between one and five years with no prepayment penalties. To be eligible, businesses need to have been trading for over a year, turning over at last $50,000 annually, have good business credit, and own at least 20% of the company.
Launched in 2012 Seedrs has seen hundreds of millions of pounds invested into deals across all industry sectors via its global investor base. It charges a fee of 6% of total funds raised plus a completion fee, but only if the campaign hits its target. Seedrs also operates a secondary market, where investors can buy and sell shares from each other. This offers the possibility of investors achieving liquidity before the crowdfunded company has achieved an exit or marketplace listing.
Crowdcube is an equity based crowdfunding platform that also helps business owners with the pre-launch process, for example, crafting a winning pitch, setting realistic funding targets and creating a communications strategy before the fundraising campaign launches publicly. It charges a 7% fee on funds successfully raised, plus payment processing fees. Companies that are approved and succeed with their fundraising goals on the platform are able to join Crowdcube’s ‘Funded Club’, with access to exclusive benefits from their partner organisations.
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How can I make my crowdfunding pitch a success? Similar to peer to peer lending, persuading people to part with their cash to make your project come alive is no easy task. Success rests on the careful planning of each step of your campaign. You'll need to find the most suitable crowdfunding platform for your business, understand your target audience and identify your buyer persona, as well as create a compelling campaign pitch – usually a video – to be shared across the most relevant social media platforms. When the first donations and investments start rolling in, your campaign’s success can be sealed by showing genuine gratitude for your supporters’ contributions and keeping them in the loop with how your project is going.
Where do I find backers my business? There are thousands of people looking to back new ideas, but finding the right backers takes careful research. For example, Millennials tend to be the biggest backers of crowdfunded projects. However, a funding request has to resonate with its target audience, and they need to be the type to use crowdfunding in the first place.
What are the risks? One drawback of crowdfunding is that you are exposing your idea on an open crowdsourcing platform, where competitors or individuals who could steal your idea and beat you to market could be present. Consider talking with lawyer to ensure your idea is patented and legally protected.
What are my chances of success? Less than a third of crowdfunding campaigns actually hit their goal. According to Statista, as of April 2, 2019, the success rate of fully funding a project on Kickstarter was 36.84%. Key to success is effective campaign marketing, which requires a huge amount of planning before launch, and ongoing efforts to maintain campaign momentum.
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