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How crowdfunding works for businesses
For small businesses to grow, sometimes you need to borrow capital – but it can be difficult to qualify for financing when you're a new business.
Unfortunately, small businesses often don’t fit the mould in terms of what a bank or larger institution requires to offer a loan –but that doesn’t mean you’re out of luck. In recent years, the rise of crowdfunding has provided entrepreneurs with an alternative to traditional loans.
In this article, we break down what crowdfunding is, how you can reward your backers and tips to running a successful campaign.
What is crowdfunding — and how does it work?
Crowdfunding is the process of raising money for a project or product online in small increments. Friends, family and even strangers can contribute small sums of money to help you reach your total goal. What donors receive in exchange can vary based on the type of crowdfunding you use. There are four types of crowdfunding: donation-based crowdfunding, rewards crowdfunding, equity crowdfunding and peer-to-peer crowdfunding.
Donation-based crowdfunding allows individuals, entrepreneurs and small businesses to set a goal for funding. Individuals can donate money simply to help reach that goal without gaining anything in return.
GoFundMe is one of the most popular donation-based crowdfunding platforms out there. The site allows users to collect funds regardless of whether they’ve met their stated goal. Unlike other platforms, GoFundMe doesn’t offer rewards to backers.
- Platform fee: $0
- Processing fee: 2.9%, + $0.30 per donation
Rewards-based crowdfunding is similar to donation-based crowdfunding in how it relies on small donations from a large number of backers. The difference is that backers are offered different incentives that vary by the amount of their donation: A small contribution may result in no reward or a nominal thank you, while larger contributions could allow backers discounts, perks or even the actual product for the specific goal they’re backing. This method of crowdfunding is great for startups that want to test their idea on the market – if your budding business can’t attract funds with the promise of a copy of your product, then it probably won’t be enticing to customers.
Of the rewards-based crowdfunding platforms, Kickstarter and Indiegogo are among the best known.
- Platform fee: 5%
- Processing fee: 3% + $ 0.20 per pledge, or 5% + $ 0.05 for pledges under $10
Kickstarter could be a great platform for creative projects and not so great for startups. You’re required to use the funds to make something that’s shareable — like a music album, book or video game. In other words, you can’t use Kickstarter to raise seed money or grow your business.
It’s also all or nothing, meaning you won’t be able to access your funds until you reach your goal. And there are limitations on what types of projects you can finance and what you can offer as a reward. For example, you can’t finance any project related to energy drinks, gambling or financial services. And you can’t offer alcohol as a reward.
- Platform fee: 5%
- Transaction fee: 2.9% + $0.30
- Transfer fee: $25
Indiegogo is an international crowdfunding platform that could be ideal for entrepreneurs. While it might be more expensive than GoFundMe, it can hook you up with experts that specialize in marketing, creative services, prototyping, production and distribution. It also waives the platform fee for nonprofits and socially minded campaigns.
Indiegogo campaigns offer businesses a choice between flexible or fixed funding. With flexible funding, you keep all of the money you raise — whether or not you meet your goal. With fixed funding, you can’t access the funds until after your goal is reached, and if you don’t then your backers get automatically refunded.
Benefits of rewards-based crowdfunding
Here are some of the perks that come along with this low-cost, low-risk financing option for small businesses:
- It’s inexpensive. You typically only have to pay a 5% platform fee and a processing fee of 3% plus $0.30 to raise money.
- No credit check. Your personal credit score doesn’t matter when you make a crowdfunding campaign.
- No collateral required. You also won’t risk losing your business or personal assets through rewards-based crowdfunding.
- Won’t lose ownership. With rewards-based crowdfunding, you don’t have to give away equity in your company in exchange for donations.
- Increased brand awareness. The marketing that goes into your crowdfunding campaign can help familiarize people with your company and products — even if they don’t donate.
Drawbacks of rewards-based crowdfunding
Thinking of setting up a rewards-based crowdfunding campaign for your business? Consider these potential drawbacks first:
- Not great for large amounts. It can be hard to raise more than $100,000 through rewards-based crowdfunding. Instead, you might want to look into business loans or equity crowdfunding.
- Fixed funding. On some platforms, you don’t get to keep any of the funds you raised if you don’t meet your goal.
- Exposure to competitors. There’s a chance a competitor might see your campaign and try to steal your idea.
- Not ideal for all projects. If you don’t have a product that’s exciting to the general public or only work with other businesses, you could have trouble raising funds.
- It’s an investment. Making a successful crowdfunding campaign can take a lot of time and effort that some businesses might not have the bandwidth for.
Some crowdfunding platforms allow small businesses to get funding in exchange for equity. With this model, backers can become shareholders, gaining a percentage of the potential future return. You can also find some speciality platforms for equity crowdfunding.
Crowdfunder and CircleUp are two widely used platforms for equity investing. To use Crowdfunder, you pay a flat monthly fee between $0 (for a basic account) up to $499 (for a premium account), while CircleUp takes a percentage of the funds you raise. (These fees are accurate as of September 2019).
Unlike other crowdfunding models, peer-to-peer (P2P) fundraising can widen the audience you reach with your fundraising efforts. With P2P, individual backers reach out to their own social networks to raise funds. On the platform Classy for example, instead of offering incentive levels with equity, nonprofits encourage team members to organize campaigns and can then offer incentives like T-shirts or other tangible rewards outside of the platform.
For a less public way to request funding help, you could apply for a small business loan through a peer-to-peer lender like Lending Loop. This lender allows individuals to fund whole or partial loans to small business owners. Lending Loop is Canada’s first regulated P2P exchange.
Crowdfunding benefits and drawbacks
- You can use your social network. Leverage your friends, family and acquaintances to support your project. This is great for startups that are looking to raise money for their business.
- Access to crowdfunding communities. Popular platforms have their own following, giving you access to a wider audience.
- Get valuable project feedback. How individuals respond to your funding campaign can provide feedback on whether there’s interest in your venture — before you spend the time, money and effort bringing it to the market.
- Incentives for customers. Providing rewards, special perks and even equity can be a great way to entice potential customers to provide funding for your business.
- You can get funds quickly. Crowdfunding platforms typically give supporters a 30-90 day window to provide financial backing for your business. The short timeframe can lead you to get funding much quicker.
- You can exhaust your social network. If you’re relying on your social circle for funding, choose projects carefully to avoid bombarding your friends and family.
- You’ll need to invest time into your campaign. If you want people to back your project, you’ll typically need a sharp-looking video and an enticing and informative campaign page.
- It comes at a cost. You’ll likely pay some fee or percentage to get funded. With rewards crowdfunding, you have to deliver the incentives you promise as well as give up a percentage of your earnings, while you’ll also have to give up a percentage of your earnings with equity crowdfunding.
9 tips for a successful crowdfunding campaign
- Reach out to your social network. This is the time to call in favours. Even small donations will add up to a successful crowdfunding campaign.
- Put together a solid marketing plan. You can’t just put your campaign up and hope for the best — especially on Kickstarter and Indiegogo. Plan transparent marketing through social media, video and email to spread the word about your campaign.
- Produce a crowdfunding video. Detailing your project through a compelling video can personalize your goals and get people excited. Facebook continues to prioritize video in its newsfeed, potentially influencing the visibility of what you’re working on. If you’ve never made a video before, consider hiring a consultant.
- Know how much you actually need. Each crowdfunding platform comes with its own fees. Learn what you’ll pay, and adjust your goal so that you don’t end up short.
- Focus on the benefits for your backers. You’re crowdfunding to finance your business — but your backers will want to know what’s in it for them.
- Do your research. Look at other successful campaigns for a project like yours. Take notes about what works — and what doesn’t — to help guide your own.
- Come up with a pitch that’s short and sweet. You should be able to explain the problem your product or company is fixing in 30 seconds or less. This can help you market your campaign and create any media that goes with it.
- Give limited rewards for rewards-based crowdfunding. Limit the timing on your rewards in order to encourage people to donate now instead of putting it off.
- Don’t start too early. While there’s no perfect time to start a crowdfunding campaign, you might not be as successful if you don’t have a solid idea of what your product or company is going to be.
Frequently asked questions about crowdfunding
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