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.

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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.

Four types of crowdfunding

  • Donation-based 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.

  • Rewards crowdfunding

Rewards 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.

  • Kickstarter works with a goal-based model: You set a goal at the start of your campaign that you must reach in order to receive your funding. This places more importance on setting reasonable goals. You will be charged a 5% fee if your project is successfully funded as well as a payment processing fee of 3%, while an unsuccessful project won’t be charged a fee at all. (These fees are accurate as of September 2019).
  • Indiegogo doesn’t come with the same all-or-nothing approach. Instead, you can choose to pay a fee of 5% in order to receive funding whether you hit your goal or not. The upside is that you get your funding no matter what — but without a goal, you could be missing out on a motivator for both yourself and for your backers. In addition, you’ll face a payment processing fee of 2.9% + $0.30, as well as a $25 withdrawal fee. (These fees are accurate as of September 2019).

If you’re in a specialized industry, you could find smaller platforms focused on speciality business niches like nonprofits or health care.

  • Equity crowdfunding

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).

  • Peer-to-peer crowdfunding

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

Pros

  • 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.

Cons

  • 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.

Five tips for a successful crowdfunding campaign

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.

Frequently asked questions about crowdfunding

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