How does crowdfunding work and is it a good option for small businesses?

How does crowdfunding work

As a business owner looking for the perfect funding solution, an alternative to business loans is crowdfunding. This approach can provide a start-up or established small business with finance by obtaining small amounts from a large number of people until they reach their funding goal.

Crowdfunding has grown in popularity, as an alternative way for businesses to raise funds without having to sign up to credit agreements. For some businesses, crowdfunding can open doors to funding that would otherwise be firmly shut. But for others, is crowdfunding really the best option?

How does crowdfunding work?

The concept behind crowdfunding is simple. You ask lots of people for a small amount of money for your cause. In the business world, this is often seed funding or money that will be spent on a specific project.

Crowdfunding usually takes place through online platforms, such as Kickstarter, Crowdfunder, Gofundme or Fundable, which provide out-of-the-box marketing solutions for crowdfunding projects. This can be shared far and wide through social media or business websites, for example. The business owners must establish their target funding amount and the time span over which they will attempt to raise all of the money.

What type of business usually runs a successful crowdfunding campaign?

Businesses that are most successful when raising money through crowdfunding are usually those that have an existing engaged customer base or those whose business interests can be given a social or environmental responsibility spin. Other business projects that can attract a lot of positive attention through crowdfunding are businesses raising cash for technological innovations.

For example, a popular local chef may start a crowdfunder to raise the money they need to fit out their first restaurant, or a t-shirt designer may use crowdfunding to raise the cash they need to buy screen printing equipment and start selling their designs in bulk. Other projects that may do well crowdfunding could be a beer making business wanting to renovate a much-loved old brewery building, for example.

What these fundraisers have in common is that they can appeal to the public on more than just a commercial level. They have a story to tell and can bring their investors along on their journey.

Are there different types of crowdfunding?

There are several different approaches to crowdfunding and, if you are considering having a go at it yourself, you’ll need to think carefully about what form of crowdfunding is right for you. The types of crowdfunding can be categorised along the lines of what the investors get in return:

Rewards crowdfunding:

Some crowdfunding projects offer members of the public a reward in return for their investment. This would be effective for those who have a loyal following or established customer base already. For example, the t.shirt designer might offer two free t.shirts in return for a contribution to their crowdfunder, while the chef may offer a dinner for two. These rewards are often linked to the project for which the cash is being raised.

Equity crowdfunding:

This type of crowdfunding could be more widely used and offers investors a stake in the business in exchange for their contribution.

Donation crowdfunding:

Sometimes a crowdfunder is seeking donations to their project with no expectation of anything in return. In these situations, though, the project almost always has a social or environmental responsibility angle.

The problem with crowdfunding

While crowdfunding may seem like the perfect solution to your funding issues, there is a whole range of problems with crowdfunding, which need to be given some consideration:

  • It’s all or nothing - so many crowdfunding sites only actually make good on the public’s investment and donations if you succeed in reaching your funding goal. If you fall short, that’s it, no cash.

  • There are fees to pay - crowdfunding sites charge fees to businesses using their platforms to raise cash. For example, Crowdfunder.co.uk will take 5% of the money you raise, plus charge transaction fees. Kickstarter.com will also take 5% of your total raised and charge a further 3-5% in transaction fees.

  • You’ll need an engaged audience - If you don’t already have a decent social media following, a robust email list, or an existing customer base you may struggle to successfully promote your crowdfunding campaign and hit your targets.

  • You’ll need patience - crowdfunding targets are usually set for somewhere between 30 and 90 days. This means you’ll be waiting months for your cash to come through. And if you don’t reach your target, there may be no cash at all.

  • What are you giving away? - On top of the fees, you’ll usually have to give something away in return for your money. Equity in your growing business has value and you need to establish this before starting the crowdfunding process. Although your business may be in its infancy right now, from tiny acorns mighty oaks grow, and you’d be foolish not to protect yourself and your business interests right from the start.

What are the advantages of crowdfunding?

So, although crowdfunding may not quite be the source of free money you thought it was, it does offer some perks:

  • It can help you establish your customer base and validate your ideas - If your crowdfunder is a great success, you know that plenty of people believe in your ideas. You may even have drummed up enough interest and business to help prop you up through the first months of the project.

  • If you fail to meet the minimum criteria for a business loan, a crowdfunding campaign might still be within your reach.

Could a business loan be a better option than crowdfunding?

Some business owners looking to raise finance might feel that a business loan isn't an option for them. If they have been operating for less than a year, or have a less-than-perfect business or personal credit record, for example, they may have ruled out a business loan.

Others may be seeking finance without having to pay the interest that comes with a business loan. Many consider crowdfunding to be a cheaper option than a business loan but this isn’t always the case.

When you embark on crowdfunding, consider what you are giving away:
  • A percentage of the money raised if you are successful

  • A fee for transactions, such as withdrawing your cash once you’ve raised it

  • The value of any equity you have given in exchange for money

  • The value of any special gifts or offers you have given away in exchange for money

  • Any costs incurred over the months you will have to wait for the crowdfunding campaign to run its course

  • Any costs you may incur if you fail to meet your fundraising goals

Business loans through direct lenders operating online can be much quicker and easier to obtain than traditional bank loans. We don’t treat small business owners like we’re doing them a favour by lending them money. We all gain from the arrangement, but business owners know what the costs will be upfront, they know they could see the money in their account within hours and they can remain secure in the fact that they will keep all their equity.

We believe in the businesses that we back with our loans and we want to see them grow and flourish. That’s why simple, good value, alternative business loans are often the right funding option for businesses of all sizes.

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