Need some extra capital for your business? With the rise of crowdfunding sites such as MicroVenture’s First Democracy VC, Fundable, Kickstarter and more, crowdfunding is a growing source of funding for small- to midsize-businesses. In fact, according to Fundly, crowdfunding has raised more than $34 billion globally. Crowdfunding allows small businesses to raise equity through investors, neighbors, customers, friends and family via an online platform. Merchants can build a case for their business online and potential investors invest right on the site. In exchange, crowdfunding sites charge a percentage of the money raised—usually between 5 and 13 percent—or a service fee.
There are four types of crowdfunding models popular right now:
- Equity. In this model, accredited investors become part-owners of the company by purchasing equity shares. Contributors are expected to receive a financial return and a portion of the profits either as a dividend or distribution.
- Donations. This is a flip of the equity model—contributors receive no financial return for investing. They are donating their money because they believe in what your business stands for. These crowdfunding campaigns are popular for charities and nonprofits, and are reported to be the second most-popular type of crowdfunding.
- Rewards. Reward-based crowdfunding is more of a hybrid. Investors receive a reward, usually in the form of a free product or service, but they don’t receive a portion of the company or profits. In this model, anyone can invest in your business. For small businesses, this can be a great way to test a new product or new market. Examples of rewards might be discounts on services, free drinks with the purchase of a meal for a limited time, or a free consultation.
- Debt. Also known as micro-lending, this type of crowdfunding is more like a traditional loan. Contributors will receive their money back over a payment period with interest. This type of crowdfunding is estimated to represent the largest form of crowdfunding, bringing in about $25 billion in peer-to-peer lending globally.
Crowdfunding offers many benefits including:
- A wider pool of investors than traditional banks. By putting your business on a platform site you’ll get exposure to a wide assortment of accredited investors, not just your local bank, with no additional effort on your part.
- A depersonalized way to ask your personal network for funds. It can be awkward to approach family and friends for money. Creating a site allows them to read through your plans without feeling pressured, and choose to invest or follow your campaign. Even people who are not interested in investing may become a customer or support your business in another way.
- More visibility for your business. This applies both to investors and potential new customers. Crowdfunding sites are another platform for spreading the news about your business and what makes you unique.
- A more flexible way to apply for funding. While crowdfunding still requires that you adequately describe your business and its prospects, it allows for less traditional (and potentially more compelling) submissions such as videos.
- The viral factor. At some point, as your campaign builds interest, it can reach a tipping point where excitement generates more even more attention and funding. In addition, investors are personally invested in your success, which can lead to a network of loyal advocates.
- Crowdsourced ideas. By presenting your business to a large pool of potential investors, you’ll also likely get a number of ideas on how to refine your business plan and make it more financially secure.
Wildly successful crowdfunding campaigns often get media attention and it’s easy to get caught up in the excitement. Before you sign up, though, consider some of the potential drawbacks if you decide to give equity crowdfunding a shot:
- Sharing a portion of the profit. Per the terms of your funding you’ll owe either a dividend or a distribution—which are a portion of your profits.
- Partners. Sometimes partners bring additional expertise and access to a better network…but they also bring the risk of conflict, and to some extent, a loss of control over a portion of your business.
- Regulations are in flux. As a new form of financing, crowdfunding rules are bound to change.
If you think crowdfunding might be a good fit for your business, make sure your business is ready for the exposure. Investors will want to know you’re on top of your game and have a plan for making your vision work. Depending on which type of crowdfunding campaign you choose, you may need to present a formal business plan. Even if you don’t, going through some basic strategic planning will help make your campaign more persuasive.
Before starting a campaign, you may also want to take some time to build and organize your contacts and to develop a compelling story. While crowdfunding sites help get you in front of potential investors, odds are most of the initial money will come from people within your network. Make sure you have a plan for advertising your crowdfunding campaign through social media, email, and word-of-mouth to your entire network including customers, other local businesses. (Check out this post for tips on social media marketing for small businesses.)
Also review other alternatives to crowdfunding and traditional bank loans. Clover Capital, for example, is a program that allows small businesses to borrow against future credit card sales. Want more ideas to get funding for your business? Check out our post: How to get quick cash for your small business.
Clover is sold by leading U.S. banks including Bank of America, BBVA, Citi, PNC, SunTrust and Wells Fargo. You’ll also find Clover at our trusted partners including CardConnect, Restaurant Depot, and Sam’s Club. For more information, visit us at clover.com.