Now for something completely different.
The other options in our eight-part series on Funding a Business involve either individual investors or companies like banks and venture capital firms. This week’s tutorial focuses on something else: the crowd.
While forms of crowdfunding have been around for centuries, being used to finance, for example, a Mozart concerto and the Statue of Liberty’s pedestal, it’s really only in the past few years that the technology has advanced to the point where it’s a viable funding option for many small businesses.
In this tutorial, you’ll learn how crowdfunding works, what the pros and cons are for your business, and how to run a successful crowdfunding campaign. You’ll understand whether it’s a viable option for you, and be equipped with some helpful tips if you do choose to pursue it.
1. How Crowdfunding Works
There are dozens of different websites offering crowdfunding, all with their own models, but here’s how it generally works.
You go to one of the crowdfunding sites and create a listing detailing how much money you need, what you need it for, and what you can offer in return. Your listing runs for a set period of time, say 30 or 60 days. Then people pledge money to your campaign, and you raise money for your business, typically by having hundreds or even thousands of people each contributing a small amount.
For example, you might create a listing on Indiegogo.com, asking for $10,000 to open up a new coffee shop. You explain what your plans are and why people should pledge money to you, and then offer a series of rewards. People who pledge $5 might get a free cup of joe when you open, while those pledging $25 get a personalized coffee mug, and people pledging $150 get their names engraved on one of the tables. You publicize your campaign, encourage people to sign up, and if you get enough pledges, you receive the $10,000 to open the new shop.
As well as Indiegogo.com, other popular options for raising funds are Kickstarter.com, Fundable.com and Crowdfunder.com. There are crowdfunding sites in many different countries, like Seedrs in the U.K. and SeedMatch in Germany, and some of the U.S. sites are open to businesses from other countries.
While offering perks and rewards is a common model, it’s also possible on some sites to offer equity in your company. So instead of offering a personalized coffee mug, you’d offer a share of your future profits.
Whichever model you go for, the key is to inspire people to invest in your business, either by having a wonderful concept, or by offering great rewards. And you’ll also need to work hard to get the word out. We’ll look at that in more detail later on, but first, what are the pros and cons of the crowdfunding approach?
2. Advantages of Crowdfunding
A successful crowdfunding campaign can have huge benefits for small companies. Here are some of the main advantages of this approach:
One of the biggest advantages of crowdfunding is that it’s both a funding and a marketing campaign rolled into one. If you do it right, you can not only raise money, but also make a lot of people aware of your business, and convert customers into true fans.
These days that’s more important than ever. If you have a legion of fans with a true stake in the success of your business, they’ll talk about you on social media, recommend you to their friends, and send more customers your way.
This is most powerful, of course, when people have an ownership stake in your company, but it can also work just as well when all they’re getting is perks. What matters is that people identify with your company and want it to succeed, and a crowdfunding campaign is a great way to make that happen.
Availability to Small Firms
Some of the other options we’re looking at in this series have strict eligibility criteria. To get a loan, you have to demonstrate a strong financial track record, and to attract many types of investor you need to be a certain size or be able to deliver a certain return on investment.
Crowdfunding, on the other hand, is open to a much broader range of companies, even very small start-ups. The main criterion for success is an ability to engage and motivate people to invest in your project. There are usually no up-front fees to run a campaign, with the sites instead taking a small percentage of whatever money you raise. All of this means that crowdfunding may be a viable option for you when lots of others doors are closed.
If you’ve managed to convince thousands of people to invest in your company, that’s a powerful piece of social proof. You can use your successful crowdfunding experience in your marketing campaigns to new customers, and also when you’re pitching to potential investors in the future.
Be aware, though, that this can work both ways. If you’re unsuccessful, your unfunded project stays up on the crowdfunding site and acts as negative social proof. Most people probably won’t see it, but a potential investor might come across it if they’re researching your company in detail, and it could harm your reputation.
Companies have traditionally spent a lot of time and money on testing their new products with focus groups of consumers. With crowdfunding, you have a massive, ready-made focus group for your product.
For example, Canadian company Top & Derby, which sells walking canes online, raised $22,000 last April on crowdfunding platform Indiegogo. Co-founder Ben Grynol said the value was not just in the money received, but also in proving that people would pay $70 apiece for a designer cane, and getting feedback about the product from potential customers.
3. Disadvantages of Crowdfunding
Despite these advantages, crowdfunding is not right for every company. Here are some of the downsides:
Major Time Commitment
It’s called a crowdfunding “campaign” for a reason. To be successful, you can’t just put something up on the web and hope people go for it. You really do need to plan your pitch like a politician’s election campaign. You need to build support, reach out to new potential backers, communicate extensively with existing backers, and then deliver promptly on whatever you promised to give people.
We’ll look more at the steps involved in a successful campaign in the next section, but suffice it to say, it’s not a simple process.
Occasionally, a crowdfunding campaign really strikes a chord with people, and raises spectacular amounts of money. Pebble Technology, for example, raised more than $10 million from a Kickstarter campaign in 2012, getting backing from almost 69,000 people for its “smart” watches.
But for most campaigns, that’s not the case. Most Kickstarter projects raise less than $10,000, the company says. That’s like loose change compared with the funds you could get from some of the other options in this series. Only 56 out of more than 56,000 successfully funded Kickstarter projects have raised more than $1 million.
So while crowdfunding is great for early-stage start-ups, it’s of limited use to larger, more established companies in search of substantial funding.
Only Some Ideas Work
You might have a great business concept with plenty of profit potential, but it could still be a dud on crowdfunding sites. Why? Well, the best concepts are simple, with a clear pay-off for investors — get a cool new watch at a discount price. If your business is more complicated, or too specialized or technical for most people to understand, or if you’re more “business-to-business” rather than consumer-oriented, you may struggle to garner much funding.
All or Nothing
Most crowdfunding sites work on the “all or nothing” principle — if you set a goal of raising $10,000, you’ll need to raise the full $10,000, or you’ll end up with nothing at all. This is done to make sure that companies have the necessary funds to deliver on any promises they’ve made to the people pledging money, but it can sometimes mean that you put in a lot of time and effort, only to end up frustratingly short of your goal.
4. Tips on Successful Crowdfunding
So, have you been inspired to ask the crowd for money? Here’s how to make sure you get the response you’re looking for.
Rewards or Equity?
Your first decision is which route to pursue — offering a reward, or offering equity.
Rewards are a good option if you have an idea that you know could inspire large-scale support. Be sure to set a wide range, so that people can pledge anything from a few dollars to hundreds or even thousands. The offers needs to be enticing, but also affordable to deliver — if you can’t provide the rewards you’ve promised, you may need to refund people’s money.
The equity route can give you access to more funds. Fundable.com, for example, which offers both options, says that reward offers tend to generate less than $50,000, whereas equity offers typically generate more than $50,000. It’s also good if you have a business that’s a solid investment opportunity, but doesn’t have an obvious “reward” to offer people.
The downside is that you’re giving up a share of your future profits, and you’ll also need to provide more financial details to investors. And it’s more complicated to value your company and issue stock than it is to deliver a coffee mug.
By early, we mean really early. Before you’ve even listed your project online, you should have found a few backers and convinced them to sign up.
Why? Firstly, so that you can make sure you’re offering things that people want. It can be hard to know how much to offer, either in rewards or equity, and the best way of finding out is to test out your offer on a few people first. If they don’t bite, you may need to tweak your offering before unleashing it on the general public.
Secondly, it’s important to have momentum in a crowdfunding campaign. We talked in an earlier tutorial about the “empty restaurant syndrome,” and it’s even more important here. If people check out your listing and see zero backers, they’re less likely to want to make the first move. If they see you already have 10 people signed up, they’ll be more convinced that you’re offering something worthwhile.
Natalia Rodriguez of coffee company Jiva Cubes learned this lesson from a failed Kickstarter campaign, and the second time around she asked 40 of her initial backers to pledge money early on and tell their friends. The early momentum helped her project get listed on the front page of Kickstarter, and she raised $15,000 within the first four days.
It’s unusual in business to be told to aim low, but in crowdfunding it works. If you aim too high and miss your goal, you could end up with nothing. If you set a modest goal, on the other hand, you’re more likely to get fully funded, and your listing will still continue until its end date, so you can keep on raising more money over and above your goal.
The “social proof” argument works again here — if people see that you’re already close to being fully funded, it looks more impressive and makes them more likely to back you. If they see you’re still a long way from your goal, they may have doubts about whether you can make it.
Successful crowdfunding campaigns are the ones that generate a lot of buzz. Part of that is about having a compelling listing, but a lot of it is about the effort you put in. Crowdfunding is not something you can do half-heartedly. For those 30 or 60 days, you need to be promoting your listing at every opportunity.
So be everywhere — talk about your project on social media, write guest posts on popular blogs, add a link to it in your email signature, mention it in face-to-face conversations, and of course answer any questions on the crowdfunding site itself. It’s a big time commitment, but it’s necessary if you want to keep that momentum going all the way through the campaign.
5. Other Options
So crowdfunding is a very promising option for funding a business. It’s available to companies that may not qualify for other funding routes, and it can be a great way to raise funds and also win new fans. But you also need to take into account the large time commitment, the need for an inspiring reward, and the comparatively small amounts of money most businesses raise.
Now that you know how crowdfunding works, and how you could use it to raise funds for your business, we’ll continue our Funding a Business series next week with a look at another option: angel investors. From crowds to angels, the journey continues...