Small business owners and entrepreneurs with great ideas consider crowdfunding a viable startup funding option. There are many crowdfunding sites, and all of them can increase exposure, build an audience, and leverage small contributions to fund a business. However, success rates are low and business owners should consider crowdfunding pros and cons before starting.
Pros of Crowdfunding
Crowdfunding can reward small business owners and startups, both financially and in terms of exposure to a new audience. Successful campaigns on top crowdfunding sites can reach a large audience and help entrepreneurs build a community around the product. Backers can also provide valuable feedback, and the process can create opportunities to connect with industry leaders beyond the initial project.
Some benefits of crowdfunding include:
1. Low Overall Risk
While the average crowdfunding campaign raised $26,400, the largest campaigns exceed $1 million, giving entrepreneurs the money necessary to build great products. While there are some administrative and payment processing costs, the overall investment required to start a campaign is low and if it fails, the business is not worse off.
2. Increased Exposure
Most startups don’t have a large marketing or public relations department. Many turn to crowdfunding because of the added benefit that exposure of the product can bring, like new customers and investors. The largest crowdfunding platforms have 17 million users, and many media outlets watch for trending campaigns to write stories. The existing community and exposure can all bring new exposure, backers, users, and customers to the company.
“In 2013, we were hobbyists, and we launched our first campaign on Indiegogo for our portable and foldable 3D printer: it went well, and we got international exposure. Our idea was validated, and we made real work out of our hobby and founded Lumi Industries. Our company is well-known abroad because from day one, our clients were from all over the world.”
— Davide Marin, Co-founder of Lumi Industries
3. Established Audience
While social media has increased the reach of individuals beyond immediate circles, most small businesses and entrepreneurs don’t have a huge following when they start. Crowdfunding platforms are unique because users browse them in search of new products and ideas, and addressing that audience can amplify an entrepreneur’s message. Entrepreneurs who run successful campaigns can convert part of this audience into backers and future customers.
4. Community Building
Building a community around a product or a service can be valuable for feedback, testing, and discussion. Early supporters are often eager to test new versions of a beta product and are likely to promote the products in their social circles. Running a crowdfunding campaign can help a business identify this group and leverage their enthusiasm for everyone’s benefit.
“I have a one-on-one relationship with people who believe in my writing. I have the enormous satisfaction of knowing it’s not the faceless Amazon customer who purchases one of my books online, nor the bookstore customer who will never give me feedback, but real people with skin in the game.”
— Latayne C. Scott, Ph.D., Author in Residence, Trinity Southwest University
5. Feedback Collection
With a community and backers, it becomes easier to collect feedback. While some supporters may provide feedback about the campaign, others can suggest ways to improve the product, rewards, and offering of the company. Entrepreneurs need not worry about addressing every idea, but having a group of supporters who provide feedback can be valuable in refining the offering and identifying product and market fit.
“Artists who use concert crowdfunding have control over their fan base information; in addition, all pledgers’ stats are available in your campaign profile and not left locked away at the ticketing company.”
— Karen Chiftalaryan, Founder & CEO of Show4me
6. Product & Idea Validation
Entrepreneurs are sometimes uncertain whether the product they are developing has a large market demand. If the product requires extensive manufacturing and logistics planning, it can be important to validate the product with a crowdfunding campaign first. An early rejection can save entrepreneurs time, money, and further effort. However, early acceptance and validation can help entrepreneurs justify fundraising from angel investors to fund a large operation.
“With crowdfunding, you can see if there is a demand for your product. This prevents one thing that many of the business owners who fail every year are guilty of. They fall in love with the product instead of falling in love with how they can help their customers.”
— Sandra Hinshelwood, Founder of Business Partner Magazine
7. Increased Momentum
Building momentum and excitement around a product is one of the largest benefits of running a successful crowdfunding campaign. Large campaigns often receive coverage in the media, attention from bloggers, and extensive exposure on social media, and that hype can drive support and result in sales. However, businesses that run crowdfunding campaigns should ensure they are truthful about the product and delivery times to avoid disappointing followers and contributors.
“Effective campaigns I’ve seen always have a unique and timely product idea that resonates with its audience. They create massive momentum, resulting in rapid funding for a product launch. This turns ideas into reality.”
— Ben Mirecki, Founder & President of CarPages.ca
8. Reward Flexibility
Rewarding backers is an integral part of a campaign, and entrepreneurs should think about rewards as they set up their campaign. While rewards like early access and signed memorabilia are common, some crowdfunding campaigns offer trips and meetings to big supporters or even equity. Some crowdfunding sites even allow funded campaigns to keep running, acting as a store for the company that generates sales.
“When a business has a new product or prototype, crowdfunding is an easy way to presell. Donors receive perks that include current products or new ones in development. After the campaign closes, there is an option to be ‘in-demand’ for several more months to bring in sales.”
— Cathy Payne, Author of Saving the Guinea Hogs
9. Small Individual Contributions
Raising money from the crowd is much easier than raising money from friends and family because of the volume of contributions. Crowdfunding contributors can offer small amounts of funding, but they do it so many times that campaigns can receive over $1 million with a $50 average contribution. For small-ticket consumer products, this can be the best way to raise funding and go to market.
10. New Opportunities
While preselling products, building a community, and receiving funding are great for a small business, crowdfunding sometimes provides unexpected opportunities. Entrepreneurs may find large investors in their crowd of backers, people in the media who can offer exposure, future hires who can offer expertise, and experienced entrepreneurs who can offer advice. These people can contribute beyond their donation and help the company succeed and deliver on its promise.
“Crowdfunding has limited time frames in which to raise and run your campaign. This helps to nudge investors to make up their minds and decide if they want to invest or not instead of dragging their heels. It’s better to have an outcome one way or another rather than an investment round dragging on forever with no definitive end in sight, which makes it difficult to plan for the business.”
—Sukhi Jutlam, Co-founder of MarketOrders
Cons of Crowdfunding
There are thousands of crowdfunding campaigns active at any one time and most don’t receive full funding from backers. These campaigns require extensive planning and preparation, but even with that, it is difficult to attract contributors. Successful campaigns must also pay fees, and any company that runs a campaign risks inspiring copycat products in the market. It’s still a great opportunity, but business owners should understand the drawbacks and risks before starting.
Some drawbacks of crowdfunding include:
1. Low Success Rate
Most crowdfunding campaigns are unsuccessful at meeting their funding goals. There are many factors that contribute to this, including poorly planned campaigns, products that don’t have prototypes, and a lack of a good crowdfunding business plan. Most successful crowdfunding campaigns bring in 25% to 50% of donors from their existing networks because partially funded campaigns rank higher on crowdfunding websites.
“If crowdfunding is the only financing option available to you, then do it, but make sure you’re also speaking with experts and getting smart on all of the other options out there that are better for long-term business financing. When crowdfunding, it helps to have a strong emotional tie-in, as people often think of contributions as a donation.
“It is easier to source other types of funding today than in the past, making crowdfunding less necessary. Angel investors are more willing to fund a business at early stages than they were 10 or 15 years ago, and there is a higher volume of accelerators in more locations. There are more resources and information out there for entrepreneurs, such as how to pitch a business, product pricing strategy, and more. For underrepresented minorities who still face challenges, take advantage of corporate programs like J.P. Morgan’s Advancing Black Pathways program as well as government incentives for small business loans.”
— Alton McDowell, Co-head of Technology & Disruptive Commerce, J.P. Morgan Middle Market Banking
2. Long Preparation Time
Entrepreneurs and small business owners who prepare for crowdfunding must produce videos, ads, explanations, contribution tiers, and rewards before they launch a campaign. Once a campaign is live, they need to have the staff to handle questions from contributors, readers, and media outlets. Crowdfunding can be lucrative, but it takes a lot of effort, preparation, and follow-through to run a successful campaign.
“In the startup world, we like to say crowdfunding is a full-time job, and that’s no exaggeration. If you are a busy entrepreneur, you may not be available to focus on such a big push. This is a large factor that contributes to the 66% failure rate on Kickstarter.”
3. Difficulty Getting Noticed
Crowdfunding is not as simple as launching a campaign and waiting for results. Entrepreneurs must generate buzz for their campaign, drive traffic to it, and grow their audience. Some entrepreneurs leverage social media, email lists, and word-of-mouth marketing to drive traffic to their campaigns. Creativity and reaching the right audience are key, and this can sometimes take significant capital and planning.
“You will have to hustle to get the money. You have to sell your idea, why it’s great, why you need the money, and so on. You will also have to provide a greater rate of return than you would for most traditional funding alternatives.”
— Brian Cairns, CEO of ProStrategix Consulting
4. High Fees
Top crowdfunding sites don’t charge initial setup or application fees, but business owners can expect a charge for more niche crowdfunding options. Most crowdfunding sites takes a percentage of the proceeds from a successful campaign as payment. The average fee is 5%, meaning that businesses raising $100,000 will only receive $95,000. Entrepreneurs should include this fee and any additional fees in their projections.
5. Upfront Investment
Business owners often underestimate the costs of setting up, launching, and running a successful campaign. Marketing, copy, logos, promotions, and ads can be costly. Taking these costs into account is important for startups that lack cash because they cannot be recouped if the campaign fails.
6. Imitation Products
Entrepreneurs often live in fear of someone stealing their business idea. The risk with crowdfunding campaigns is higher because every detail of the product is available to the public. Companies may see the validation and support that the product receives and recreate it themselves. Entrepreneurs should consult an attorney for ways to defend their product before crowdfunding.
“Publicly displaying ideas at such a scale through crowdfunding risks the possibility of someone else copying the idea and replicating it. Entrepreneurs who start a campaign should be comfortable with this possibility.”
— Joe Bailey, Business Development Consultant at My Trading Skills
7. False Positives
The first weeks of a campaign can be promising, and companies may rush to produce the product. However, crowdfunding campaigns collect 50% of their funds in the first and last week, so while it may look promising to begin with, it only makes sense to make any investments once the campaign has ended.
8. High Pressure
While the pressure to succeed from friends, family, and customers is always high for a business owner, the short nature of a crowdfunding campaign amplifies it. Not only do entrepreneurs have 30 to 60 days to raise all the funding that they need, but they must also execute if successful. Contributors now have a financial investment in the company’s success and may become impatient when entrepreneurs don’t deliver results fast enough.
9. Strict Rules
Most crowdfunding platforms have strict rules around the projects they accept, the rewards that business owners can offer, and the amount of information that the campaign should feature. For most businesses, these are good guidelines; however, ensuring adherence to the rules can delay funding. These rules are stricter with equity crowdfunding because backers now own part of the company.
“The compliance and procedural processes crowdfunding requires are a drawback. If you are using equity crowdfunding, you’re bringing in new nominal equity investors, all of whom will affect the cap table and your legal structure.”
— Ben Ames, Director of Growth at Corl.io
10. Reputation Risk
Companies that run a crowdfunding campaign can damage their reputation by failing to deliver products on time, overpromising or otherwise misleading their contributors. Running an honest and transparent campaign is important and goes a long way toward reducing reputation risk. If the unexpected happens, business owners should communicate with their backers to manage expectations.
Types of Crowdfunding
Most entrepreneurs know of rewards crowdfunding because it’s the most popular and receives the most media attention. Another crowdfunding option that business owners can consider is equity crowdfunding, where backers receive equity in the business and a share of future profits. Deborah Sweeney, CEO of MyCorporation.com, provides an example of rewards and equity crowdfunding that illustrates the difference between the two options for small businesses.
“Rewards crowdfunding may be found through platforms like Indiegogo and Kickstarter, where individuals who donate to the campaign receive a reward for their donation. Large donations, in particular, receive more personalized and thoughtful gifts. For example, if a baking blog is using rewards crowdfunding, a $25 donation may receive an e-book of recipes, whereas a $100 donation would receive the chance to have a cupcake named after them in addition to receiving the recipe e-book.
“Equity crowdfunding allows donors to receive shares in the company for their financial contributions. This type of crowdfunding is often done through platforms like CircleUp, which provides capital to early-stage brands. If you choose equity crowdfunding, you must know your donors are now investors in the company. The business you are fundraising for should have a business plan that positions it to be on track for success.”
Whether business owners choose rewards or equity crowdfunding, many of the same advantages and drawbacks apply. The type of business that entrepreneurs are building is the key to choosing the best type of crowdfunding. While consumer products are best for rewards crowdfunding, a more traditional small business, like a restaurant or a high-growth startup, may benefit more from equity crowdfunding.
Crowdfunding Frequently Asked Questions (FAQs)
Crowdfunding is available across multiple platforms with different rewards structures and specializations. It’s no wonder that business owners often have unanswered questions when doing research. We answer the most frequently asked questions about crowdfunding below.
Do you pay back crowdfunding?
Business owners who borrow from a peer-to-peer lender must repay the funds they crowdfund; however, money they raise with rewards or equity does not require repayment. In most cases, contributors receive something right away or when a product launches for their support, and crowdfunding campaigns must make good on those promises.
What percentage does a crowdfunding platform take?
Crowdfunding platforms take as much as 10% of the funds that a business raises, but the amount can be as low as 0% and averages 4% to 5%. Each crowdfunding platform provides a fee disclosure and also charges campaigns a credit card processing fee for each contribution.
Which business crowdfunding platform has the lowest costs?
Business owners who do not meet a fundraising goal rarely incur any direct costs from the platform. However, the lowest cost platform to raise debt crowdfunding is Kiva. Kiva is a nonprofit that offers business loans up to $10,000 with no interest and long repayment terms.
Business owners can summarize the pros and cons of crowdfunding as a huge opportunity with a limited downside that requires extensive preparation and has a low success rate. Business owners who run a crowdfunding campaign should be comfortable with the risk of failure before starting. Successful campaigns get customers, funding, and product validation, which is a unique and comprehensive offering for most businesses.