How Crowdfunding Works For Entrepreneurs
How does crowdfunding work for startup entrepreneurs?
Crowdfunding exploded onto the internet a few years ago. Since then early platforms like Kickstarter and Indiegogo have seen hundreds of new crowdfunding platforms emerge onto the scene, fueled and transformed by the new JOBS Act. How can this help entrepreneurs launch and grow their startups? How does this fundraising strategy compare to other options? What do you need to know before you try it?
What is Crowdfunding?
As the name suggests, this is all about engaging the crowd to co-fund projects and startup ventures. Funding can be provided by tens, hundreds or thousands of individual investors, as well as institutional investors and their conduits.
They come together to provide the money needed to get an idea off the ground, complete production or finance the next stage of growth.
Crowdfunding: What’s New & Not
The way crowdfunding is presented today brings together many modern elements and new concepts. Even if the ventures and products themselves aren’t technical, today’s platforms are very tech savvy. They are designed to automate much of the processes for fundraisers and funders.
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From your phone you can browse almost endless campaigns, and invest with a couple of clicks. Crowdfunding platforms do much of the detail and heavy lifting work for those seeking capital too. Such as payment processing, legal disclaimers, investor updates, and bookkeeping.
Yet, the concept of crowdfunding has been around for centuries. Those with capital have always come together to finance bold ventures and back courageous entrepreneurs. Isn’t that how America was discovered and developed in the first place?
Today’s crowdfunding enables entrepreneurs to reach more capital partners, and giving investors a broader array of options.
Types of Crowdfunding
There are three main types of crowdfunding.
1) Donation Based Crowdfunding
Modern crowdfunding began with donation style platforms like Indiegogo and Kickstarter. When they launched it wasn’t legal for participating entrepreneurs to publicly offer shares in their business as it is now under the JOBS Act.
These platforms are still alive and well. Those with money contribute to various ventures which use that money for creating product and financing ventures. Contributors often get something tangible in return, such as being the first to receive the product.
2) Debt Crowdfunding
Debt funding is still very common for early stage startups. Especially in the form of convertible notes. However, the most basic and obvious example of debt crowdfunding today is likely peer-to-peer lending portals like LendingClub and Prosper. They allow individuals to effectively act as private lenders, and spread risk by pooling their funds to lend for a wider variety of needs. That includes car loans, startup business loans, debt consolidation, and more. Investors are repaid with monthly payments. Default rates can be high, but the yields can be too.
3) Equity Crowdfunding
These type of platforms do crowdfunding and startup investment opportunities for investors. This form of crowdfunding is most similar to traditional fundraising for startups. Where you’ll trade stock for incoming capital.
Why Crowdfund Your Startup
There are many reasons to crowdfund beyond simply gaining more money.
For brand new ventures crowdfunding is a fantastic way to prove your concept and gain social proof for later fundraising efforts. It can create a sense of urgency for investors and attract larger angel groups and VCs to later rounds.
Crowdfunding campaigns are fantastic PR tools. They help gain visibility and generate buzz. Many platforms also greatly simplify the technical and paperwork side of fundraising.
One of the most underestimated benefits is securing early users, advocates and ambassadors who have a real financial interest in sharing and empowering your success.
Where Crowdfunding Belongs in Your Plan
Crowdfunding has most often been used at the seed or pre-seed stage, and even friends and family level fundraising efforts.
New regulations have also made crowdfunding a potentially viable platform for ‘testing the waters’ before bigger expenditures on SEC filings, corporate lawyers and hard costs.
However, some have proven crowdfunding can be just as valuable for established brands and companies that have been around for years. Such was the deal with the Hard Rock Hotel in Palm Springs that pooled in 85 investors, for $1.5 million.
Crowdfunding is all about inspiring people to push your venture forward. It really comes down to mastering the storytelling and for that you will need a great video and also a detailed pitch deck to tell your story the right way. Especially if you are going the equity crowdfunding route. For a winning deck, take a look at the pitch deck template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash. Moreover, I also provided a commentary on a pitch deck from an Uber competitor that has raised over $400M (see it here).
Choosing the Right Crowdfunding Platform For You
How successful your crowdfunding campaign is will largely depend on the platform you present on. It’s important to find a good fit. This is not only true fro whether you are taking donations or offering equity, but connecting with the right funders.
For example, some platforms ban certain types of campaigns, like real estate. Others have spring up to specifically serve niches like the property market.
Do your research and find the platform with the best costs, connections to the best investors for your venture, and which will help you get the optimal visibility.
Crowdfunding Vs. Other Startup Fundraising Channels
There are some pros and cons to crowdfunding. Though this can vary greatly on the platforms you choose to use.
While crowdfunding is often promoted as an easy and fast way to raise millions of dollars, with little responsibility, it can require a lot of work and investment. Dig into the data and you’ll find some platforms have very low success rates. There can be fees for running a campaign, in addition to payment processing fees (and lag times on receiving money).
The experience will also tell you that you should have a sizable marketing budget to promote your offering, and should have at least 25% of your funding goal already committed before going live.
You may retain more control of your business with some of these platforms versus traditional startup fundraising from angels and VCs. Yet, many won’t put you right in touch with the most serious and capable investors. Some of this group may also be turned off by the lack of exclusivity.
Crowdfunding can be very profitable and beneficial. Just make sure you’ve done your research and know the costs, and which channels are the best match before rushing in.
Alejandro Cremades is a serial entrepreneur and author of best-seller The Art of Startup Fundraising, a book that offers a step-by-step guide to today‘s way of raising money for entrepreneurs.