The Pros and Cons of Crowdfunding Your New Business

24
September

The Pros and Cons of Crowdfunding Your New Business

The Pros and Cons of Crowdfunding Your New Business

Not all people with sound business ideas are able to implement them. Quite a few people fail to capitalize on their brainwave because of an old failing – the lack of funding. Traditionally, entrepreneurs have relied on bank loans, bank overdrafts and credit cards for securing funding. Some individuals have even taken loans from family members and friends. Some entrepreneurs are fortunate enough to find angel investors to back their business venture. However, neither of these funding avenues is the most efficient nowadays, at least, not when it comes to funding new businesses. Increasingly, people with worthwhile business ideas are looking at crowdfunding for financing their business ventures.


What is Crowdfunding?

Crowdfunding is a derivative of the term ‘crowdsourcing’. Crowdsourcing is the process of securing needed services, ideas or content from a large group of people – especially an online community. Similarly, crowdfunding is the process of raising capital for a business or a business idea, by using the internet and various social media platforms, to reach out to a large group of people.

Typically, the crowdfunding model involves three parties: 

  1. The entrepreneur (or the project initiator) who proposes the idea or the project
  2. The supporters, comprising individuals or groups of individuals, who support the idea or the project and,
  3. The platform (or a moderating organization), which brings the parties together for launching the project

Supporters of the idea make their contributions or donations via online platforms. Thereafter, the platforms coordinate and administer the fundraising activities.


Just How Serious is this Crowdfunding Business?

It might seem like a strange idea to many people. However, crowdfunding is big and experts suggest that it will only get bigger from here. According to Fundable:

-        The average campaign for crowdfunding lasts for about nine weeks

-        The average successful crowdfunding campaign is around $7,000

-        If a campaign can achieve 30 percent of its goal within the first week, then its chances of success are higher

-        People earning over $100,000 annually are more likely to invest in startups through crowdfunding

-        People of the ages of 24 – 35 years are more likely to participate in crowdfunding campaigns


What are the Different Types of Crowdfunding Models?

There are three kinds of crowdfunding models currently. These include:

  • Donation Crowdfunding: People invest in the project because they believe in the cause espoused by the project. Therefore, investors have a social or a personal interest for investing, without expecting anything in return. Rewards offered for investing in these projects will usually be intangible or diverse. They could include freebies, tickets to an event etc.
  • Debt Crowdfunding (or Peer-to-peer lending): In this crowdfunding model, investors receive the principal along with the interest payable. In many ways, this model is similar to the loans offered by banks because the returns are financial in nature. However, the investors contributing to this project also have the benefit of contributing toward the success of an idea they believed in.
  •  Equity Crowdfunding: Here, people invest in the project in exchange for equity. Therefore, in return for the money they invest, they receive a share in the business, project or venture. If the project becomes successful, the value of their share increases. If the project fails to achieve the desired results, the investors could even end up losing the amount invested.


Is Crowdfunding Right for Your Business – The Benefits and Drawbacks of Crowdfunding

The Benefits:

Crowdfunding is beneficial because it:

-    Saves Time and Money: Instead of doing endless rounds of banks and the offices of private investors, you can organize your crowdfunding strategy very quickly.

-    Gives You Access to Capital: It takes significantly lesser time than raising capital via traditional means. Usually, a fundraising campaign has a maximum cap of 90 days. This eliminates the need for constant pitching, prospecting, negotiating etc., which is the case when you obtain funds from banks and other financial institutions. In addition, you do not necessarily have to give up equity in your company either. Instead, you could offer reward-based incentives to your investors. You do not need to pay any fees upfront either.

-     Helps You Establish a Customer Base: Finding customers initially can be tough for a new business. However, if you’ve raised funds through crowdfunding, you effectively have a large group of people backing your offering. As a result, many of your investors do not just become your customers, but they also become an extension of your sales force as they promote your business. This is useful for bringing in additional customers. Crowdfunding also helps you engage with your customers.

-    Helps You Organize Your Marketing Strategy: When you seek crowdfunding for your business idea, you are effectively promoting your idea to others. This is in addition to seeking funding. Once you generate the funds required, you will have a clearer idea about how to make your marketing strategy more effective. In short, the clarity of the message that got you the funding will also help you attract your customers.

-    Gives You Control Over How to Reward Your Investors: Once you receive the funding required, you get to determine how to reward your investors. As long as you’re reasonable, you have complete control over how much equity or interest you can offer your investors.

The Drawbacks:

Crowdfunding is not viable because it:

-   Does Not Deliver for Business-to-Business Offerings: People generally back something because they identify with it or perceive some benefits from it. As a result, they will back offerings aimed at consumers, instead of at business entities. 

-   Does Not Work for Complex Projects: Crowdfunding works if the business idea is simple enough for the layperson to understand. Complex or technical projects might come a cropper if they seek crowdfunding. Even projects with lengthy research-and-development cycles could draw people away from investing in your idea.

-   Might Not Fund Large Capital Requirements: Barring exceptions, crowdfunding typically works for projects that require under $100,000 of capital. If your idea requires larger funding, you might need to consider looking at other traditional sources for raising capital i.e. banks etc.

-   Often Follows an All-or-Nothing Approach: Some crowdfunding platforms only release the funds from your campaign once your campaign achieves 100 percent or more of its funding goal. As such, you could be stuck in limbo if your campaign fails to achieve its target funding.

-   Makes Your Project Inflexible: Once you receive the funding you need, you cannot make drastic changes to your offering. Similarly, any delays in timelines could damage your reputation and hurt your brand.


More Reading

Not sure crowdsourcing is the best way to raise money for your new business venture? Not sure how big of a loan to take out? Read our practical guide on how to know how much money you should borrow. 


Pro-Tip

Starting a business can be a handful. Treat yourself to an edge over your competitors by gaining all the basic knowledge and skills you need to succeed with our Introduction to Management course or get a better grasp on the finances needed to manage a business with our Fundamentals of Finance course. 

You may also be interested in a very lucrative way to earn yourself either a main or residual income by means of Trading The Stock Market. This is a a very popular way to raise the funding you may need for your project. That being said, this financial market is not risk free but knowing what to do and how to invest will help you invest your money in the best possible way for high returns/ You can start by reading an excellent article on this site called: Learning The Stock Market which will give you the basics on this market and help get you moving in the right direction.

The Pros and Cons of Crowdfunding Your New Business531The Pros and Cons of Crowdfunding Your New Business

Buy Bitcoins with Paxful