Starting a new business is pointless if you cannot come up with the necessary funds to support your initial venture, and it's not always possible to convince venture capitalists or bank managers to back your vision. Therefore, crowdfunding, in which entrepreneurs try and build up capital through a large group of small donors, is an increasingly viable way to meet those startup goals.
As with many things, the internet has revolutionised crowdfunding, allowing business owners to put their idea in front of millions of people with just a few clicks. However, while the prospect of building an audience and funding your concept online sounds great on paper, there are a few harsh realities that entrepreneurs should embrace before committing to such a strategy.
To illustrate those realities, we've compiled an in-depth look at the pros and cons of crowdfunding for small businesses.
What is Crowdfunding?
First, though, it's important to clarify what exactly is meant by crowdfunding in the context of business. There are two distinct types that are generally utilised by aspiring entrepreneurs: rewards-based crowdfunding, and equity-based crowdfunding.
Rewards-Based Crowdfunding
Rewards-based crowdfunding is the approach that has arguably attracted the most media attention in recent years. It leverages the exposure of popular websites such as Indiegogo and Kickstarter to put business ideas in front of potential investors, with a convincing pitch potentially netting hundreds, or even thousands, of investors.
In return, these investors receive specific rewards depending on their level (or tier) of investment. Examples of such rewards can include early access, exclusive experiences, or any other dangling carrot that you think would help encourage people to support your business. It requires a coherent strategy first to gain exposure, and then to get people on board.
Equity-Based Crowdfunding
Equity-based crowdfunding, meanwhile, employs a more traditional investment strategy that again leverages the internet to generate interest and funds. Using this model – which is supported by sites such as Crowdfunder and Fundable – investors pledge money to receive equity in the company.
Obviously, you don't have to figure out a reward structure to encourage equity-based crowdfunding, as your investors are not expecting access to the product or service. Instead, they are investing in the future of your business, and expect to see a financial return on that investment. The downside of this from your perspective is that you lose out on full control of the venture.
The Pros and Cons of Crowdfunding for Startups
As you can imagine, both approaches possess their own positives and complications. Let's take a more in-depth look at some of these so that you can decide whether or not crowdfunding is a viable solution for your business.
Pro: It Is a Low-Risk Investment Option
One of the most appealing advantages of crowdfunding is the low level of risk inherent in the project. While you will have to deal with some administrative fees and payment processing costs, the overhead on launching a crowdfunding campaign is low. In addition, if the campaign is unsuccessful, it costs your business nothing.
This is why crowdfunding is always worth considering. Even if it isn't going to be the main avenue that you expect to use to generate investment funds for your business, you might access a market or find investors who are enthusiastic for your idea that you would never have otherwise.
Con: It Has Low Success Rates
The big disadvantage of crowdfunding platforms is that, although there are success stories, the general success rate is low. This is especially the case with reward-based crowdfunding options, as they often utilise an all or nothing investment structure, meaning that your company will not receive any money unless the initially stated investment goal is met. For example, if your goal is to raise $20,000 but you only raise $18,000, you won’t get anything. Therefore, to run a successful crowdfunding campaign, you need a plan to not only generate interest, but to make sure those goals are met.
Unfortunately, many campaigns do not hit these targets. There are many reasons for this, such as mismanaged strategies, a lack of prototypes for products, and the absence of a solid crowdfunding business plan. Be aware that, even if you think your idea is solid, there are no guarantees when following a crowdfunding investment approach.
Pro: You Can Test the Market
Getting your product or service in front of a huge audience is integral to the mechanics of crowdfunding. This process can not only generate a large amount of investment money for your new business, but can also help confirm whether there is such a market in place for the product you are hoping to launch.
One of the most famous Kickstarter campaigns was for Oculus Rift, a pioneering VR device that delivered on long-promised technology and was later acquired by Facebook. Despite the numerous false dawns of VR products, Oculus proved that the right idea packaged to the public could generate enough interest to be profitable, and this would have been much harder without the success of their crowdfunding efforts.
Con: It Can Create False Positives
While a positive response to a crowdfunding campaign is exciting, savvy entrepreneurs need to be aware of the possibility of false positives. Crowdfunding works best when it has momentum, and a lot of crowdfunding campaigns raise most of their money either during the first or last week that they are offered.
This can have effects in either direction. A lack of interest in the product may discourage a company from pursuing an idea that has merit; it may have just suffered from a poor start to its campaign. On the other hand, initial interest may push a company into rushing a product that may need more time before it is ready for market. When initial excitement dies down, a company may discover that the enthusiasm they found was fleeting.
Pro: It Helps Create a Community
A successful crowdfunding campaign will help your product to build a community, which is an integral element of a successful launch. One example of this is another Kickstarter success story: the Pebble Time watch. When the device was made available to consumers, it had almost 80,000 backers, and thousands of loyal customers waiting in the wings.
Even if you are not trying to build a community from the ground up for your product, engaging with whatever groups are already out there will be beneficial to your launch. The sooner you can start spreading your mission and the objectives of your company, the better.
Con: High Levels of Competition
The most obvious glitch in the crowdfunding process is that, due to its popularity, your ideas will inevitably face stiff competition for consumer attention right off the bat. Your idea can easily get lost in the online ether and fail to make an impact, which is why approaching a crowdfunding campaign with a plan in place is of paramount importance.
There is one other risk to consider when launching a crowdfunding campaign, especially if you are trying to get funding for something truly innovative: when your idea goes online, you are putting it where your competition can see it. As a result, there is always the risk of a better-equipped company beating you to market.
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Take your time when considering the best option for funding your venture. If you have a sellable idea that you can back up with a good marketing campaign, then crowdfunding may be a good option. However, it's vital that you approach your campaign with a well-planned strategy in place, and that you fully understand the numerous drawbacks of this approach.
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