Growing a new business often requires startup capital which entrepreneurs might not always have on hand. Fundraising is a route startups often take to secure the missing investment from backers in exchange for shares in their company. Entrepreneurs can raise capital from a variety of potential investors. Crowdfunding is a more recent fundraising innovation which allows many investors to pool together and support small businesses for a fraction of the usual investment tickets. Moreover, online crowdfunding platforms have simplified the equity crowdfunding process both for companies and investors which is why it's never been easier for a small business to raise funds on crowdfunding sites. This guide explains what crowdfunding is, the advantages and disadvantages of crowdfunding and what it takes to launch a successful crowdfunding campaign and secure business funding.
What is crowdfunding?
Crowdfunding is the process of raising funds from multiple investors or donors for a project or a cause. There are different types of crowdfunding depending on who is raising the funds and if the backers are receiving something in exchange for their funds or not. For example, a non-profit or an individual can crowdfund donations for a cause or project (e.g. Gofundme) and businesses can crowdfund investment capital to grow their business in exchange for shares in their company. An equity crowdfunding platform will usually pool the funds of the backers in order to unify the investment or donation in exchange for a payment processing fee or stake in the business which is usually a percentage of the total amount. In some cases, campaigns are cancelled if the business funding targets are not reached.
Is equity crowdfunding right for your business?
There are different reasons for crowdfunding depending on the nature and stage of your business and the amount of money being raised. For example, if you have a new business idea, crowdfunding can be a low risk and cost-effective form of market validation. Crowdfunding for businesses going to market can be a great way to raise brand awareness as a crowdfunding campaign is a form of marketing. In this case, businesses should have a compelling story and choose the best crowdfunding sites for their crowdfunding campaign based on their target audience. If your business idea or stage of your business is not likely to resonate with a consumer audience, pitching to specialised venture capitalists can be a more sensible approach to secure equity funding.
What are the advantages of crowdfunding?
There are many advantages for business owners who crowdfund. Crowdfunding usually requires running a campaign on a crowdfunding website which will expose the business to potential customers, retail investors and venture capitalists who are interested in up and coming businesses.
Companies who crowdfund can offer incentives to investors based on the amount they invest which can encourage investors to become customers and be a bit more vocal about the business. Happy customers are also a great audience to pitch the crowdfunding opportunity to as they are more likely to invest and stick with your business as a customer.
Finally, crowdfunding investors usually have less legal and investment requirements than other sources of funding such as venture capital which is why crowdfunding can sometimes be an easier route to funding if you can run a successful crowdfunding campaign. Moreover, crowdfunding platforms will usually take care of the legals which can be another advantage.
What are the cons of crowdfunding?
The disadvantages of crowdfunding need to be considered carefully before launching a crowdfunding campaign. Crowdfunding work can take a lot of time just like any form of marketing. This means that a company should only crowdfund if they can afford to allocate the resources to the campaign for it to be successful.
Another factor to consider is that unlike other forms of investment, crowdfunding sites who host the campaigns will be paid platform fees which are usually a percentage of the amounts raised and/or some shares in the company. Whilst this is not a big issue, it should be considered for budgeting and shareholder management purposes.
Because crowdfunding is very public, the consequences of an unsuccessful campaign can be very public as well which is why businesses should think carefully about their pitch and the amount of funds they are raising. Businesses who crowdfund should also be careful about protecting their intellectual property and confidential information by only disclosing details about their business which can be disclosed or requiring investors to sign a confidentiality agreement.
Finally, when running your campaign, there will also be a large number of investment opportunities and crowdfunding projects competing with each other for investment and some of the businesses might be direct or indirect competitors of your business. It is not possible to time your crowdfunding campaign to avoid competing with competitors so you should prepare for this situation if ever it does happen.
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How to run a crowdfunding campaign
There are a number of steps a business should go through to crowdfund. The first step is to determine the amount of funding to be crowdfunded, the purpose of the funding and which audience is likely to invest in the crowdfunding campaign.
A business can raise part or all their funding in a crowdfunding campaign and the amount to be raised should be reasonable as a campaign is not successful until the minimum amount is raised. The purpose of the funding will also determine where you crowdfund. If the purpose of the funding is to grow the business then the crowdfunding should be in exchange for shares. If the purpose of the funding is to launch a new product, backers will usually provide funding in exchange for early access to the new product and perks. If it is the former, you can choose an online platform like Crowdcube, Seedrs, Fundable or Republic. If it is the latter you can choose a crowdfunding website like Kickstarter, Patreon and Indiegogo.
Once you have defined the purpose of the crowdfund and the best crowdfunding site for your business, you should prepare a PR strategy to ensure that your campaign receives a maximum amount of attention. For example, if your software solution will appeal to small business owners, try to appear on business podcasts to explain what you do and that your startup funding round is open to retail investors. If you are crowdfunding for a creative project, identify creative ways of gaining attention to your campaign. These efforts along those of the crowdfunding platforms will increase the likelihood of your campaign being successful.
What are the legals of crowdfunding?
The legals of crowdfunding will depend on the nature of the campaigns. Equity crowdfunding will require the investors to enter into a shareholder agreement with the company. A crowdfunding platform will usually be the sole investor on behalf of the backers to simplify the paperwork. In this case, the individual backers will receive statements of ownership in the company they have invested in via the platform. A crowdfunding where backers are simply receiving a product or perk will simply enter into a simple terms of business with the company.
Successful crowdfunding campaigns and tips
Since crowdfunding is a form of marketing targeting retail investors, it is important to have a strong social media strategy and presence. Companies which have run successful campaigns have often managed to do so by engaging their customers. Crowdfunding campaigns should also be clear so that the problem the company is solving and the value proposition are quick and easy-to-understand for retail investors. For example, companies like Revolut and Chip have successfully crowdfunded on Crowdcube. A successful campaign is often successful because the company has
Alternatives to crowdfunding
Whilst crowdfunding can be an attractive route for raising capital, it is not the only financing option for startups depending on the stage of the business. Startups can raise funding from angel investors if they only have an idea or raise venture capital if they are more established and have a proven business plan. Startups can also raise money via convertible notes which is a form of debt which can convert to equity (instead of repaying the note and interest rates) and some crowdfunding sites can run debt crowdfunding campaigns. A business can apply for grants from the Government or institutions if there are any which meet their criteria. Alternatively, more established businesses with revenue can usually apply for business loans or bank loans which is a non dilutive approach to growing their business.
This guide to crowdfunding has explained what it is, the advantages and disadvantages and how to crowdfund. Once a business has secured funding, they then need to invest the capital into growing the business, often by hiring people. Having the right legals in place at this stage is important in order to protect the business' intellectual property rights. Using a contract management platform like Legislate allows business owners to create lawyer approved contracts on no legal budget. To create employment, consultancy, non-disclosure and all the other essential agreements, sign up to Legislate today.
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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.