Crowdfunding can help your business get the money you need to take your business to the next level. Learn about different types along with pros and cons.
One of the challenges of being a small business is finding the money for growth or ongoing operations. Sixty-seven percent of small business owners plan to expand in the year ahead, according to one report, and 12% intend to apply for a loan. Crowdfunding has become a viable method for raising capital, but it's still a minority choice: Less than 1% of small businesses have used crowdfunding to raise money, according to a survey from The Alternative Board.
That said, crowdfunding is worth a look if you're in the market for extra cash. Here's the rundown:
What is Crowdfunding?
Crowdfunding allows you to put your business idea in front of a lot of people who can choose to chip in some cash to help get it going—or grow to the next level. In exchange, crowdfunders might get the chance to receive an early sample of the product, be able to vote on product design, or receive some other perk in return for their investment. For some people, it’s enough to be able to contribute to the success of a struggling small business they believe in.
There are four basic types of crowdfunding:
- Equity crowdfunding: Crowdfund participants receive an equity stake in the business (like shares of stock) being funded. This might be an advisable strategy for companies looking for $100,000 or more in cash.
- Rewards crowdfunding: Funders receive a perk for contributing, such as early access to the product, a free gift, or even something like a paving stone with their name on it. This is typically better for companies seeking less than $100,000.
- Lending crowdfunding: In this scenario, contributors are essentially giving you a loan that you pay back over a period of time at a set interest rate. This is an alternative for business owners who don’t wish to give away equity in the business.
- Donation crowdfunding: This is what it sounds like—you’re asking the masses to give you money out of the goodness of their hearts. This is often an ideal strategy for aid organizations and social causes.
Advantages of Crowdfunding
As a fundraising strategy, crowdfunding has some benefits you should consider:
- You can raise capital. If you’re a small business that would have a hard time qualifying for a small business loan, crowdfunding might be a more viable option for you.
- You grow your pool of supporters. Depending on your method of crowdfunding, you might gain a group of people who are literally invested in your success, whether it’s cheering from the sidelines or because they now own a piece of the business. They’re also instant customers, as soon as you launch your product or service. That can be a powerful force.
- It can validate your idea. If you’re thinking of approaching venture capitalists or angel investors with your venture, a strong crowdfunding result can support your claim that your idea is bound for success.
- It can help you tweak your idea. If your Big Thing needs improvements, your crowd will let you know. This can be a solid start in market testing.
- It’s good press. If you’ve got a standout idea, your campaign could go viral and gain a lot of attention, which can help you grow in other ways.
Disadvantages of Crowdfunding
Though it has its high points, crowdfunding isn't without some downsides:
- Some platforms charge fees. Not every dollar you raise is going into your pocket. Creative venture crowdfund site Indiegogo, for instance, charges 5% of total funds raised plus payment processing fees. GoFundMe charges payment processing fees of 2.9% plus 30 cents per transaction. (That said, you’d also pay money for a bank loan.)
- You might get nothing in the end. Some platforms, such as Kickstarter, require that you meet your funding goal in order to receive the money that funders have sent your way. The idea here is that if you can’t meet your funding goal, you can’t successfully fund your project anyway—and it probably isn’t super compelling if you can’t find enough backers.
- You can give too much away. If you miscalculate your rewards or equity structure, you could end up giving up too much of your capital or granting too much equity to investors.
- You must target the right audience. Millennials are 70% more likely than Gen Xers to give to a crowdfunding campaign, and three times more likely than Boomers. If your idea is targeted to the older set, it may be tough to hit your crowdfunding numbers.
Alternatives to Crowdfunding
If crowdfunding doesn’t seem like the answer to your capital needs, there are alternatives: You could apply for a traditional bank loan, or you could ask friends and family for a loan. Angel investors and VC investors are other options, although they generally ask for a big cut of the business in return. You might also be able to land a small business grant—talk to the small business association in your area.
If you’re unsure of the right path for you, try your local small business development center—many of them offer guidance and advice. SCORE also offers free small business mentoring. If you’re willing to do the research, there are ample resources available for the enterprising small business owner.