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- There are several types of crowdfunding, such as reward-based, equity-based, debt-based, and donation-based
- Crowdfunding can help businesses avoid startup loans and the associated fees and interest rates
- Crowdfunding may require significant time investment and could have risks, such as intellectual property theft
Starting or expanding a business often requires getting a bank loan. But banks tend to have strict lending requirements, making it difficult for certain businesses to qualify.
If a business loan isn’t an option, crowdfunding is an alternative that allows you to raise business capital, often through donations. It is a popular and growing global market, expected to reach more than $28 billion by 2028 while remaining accessible to any business needing funding.
To determine if crowdfunding is the right choice for your business and funding needs, read on to learn the pros and cons and the most common types of crowdfinancing.
Types of crowdfunding
There are several types of business crowdfunding. Two of the most common are reward- and equity-based funding, which require some exchange between you and your investors.
Less common options include debt-based crowdfunding — in which you’re required to pay back your investors — and donor crowdfunding, where donors give you money with no strings attached.
Reward-based crowdfunding, sometimes called seed crowdfunding, requires you to come up with a reward plan. This may include free products or services.
For instance, you may offer investors a free sweatshirt from your clothing company once your business is up and running. You may create different tiers of rewards based on the amount of money a person invests. One of the most popular platforms for reward-based crowdfunding is Kickstarter, where nearly a quarter-million projects have been funded.
If you choose an equity-based scheme for your crowdfunding, you will offer shares of your company in exchange for financial investment. You essentially avoid upfront debt by selling securities in the form of equity, revenue shares and more. You can raise up to $5 million per 12-month period using Regulation Crowdfunding.
On the list of potential downsides, strict federal and state filing requirements must be completed once your funding period concludes.
If you plan to use equity-based crowdfunding, pay close attention to which platforms offer this option. Wefunder is one equity crowdfunding platform, but Kickstarter does not allow this type of crowdfunding.
Debt-based crowdfunding is similar to a loan. But business owners work with multiple investors or contributors instead of working with one lender and then repay the amount donated, plus interest, within a specified period.
While many platforms charge interest, Kiva is a unique debt-based crowdfunding option offering interest-free microloans loans from $1,000 to $15,000.
Businesses raising capital through donation-based crowdfunding rely on donations to cover startup costs or a project, but the donors don’t receive a reward, product or equity in return for their contributions.
- Crowdfunding may help some businesses avoid startup loans
- The two most common types of crowdfunding are reward- and equity-based
- You may have to return crowdfunding money if you don’t reach your goal
Compare pros and cons of crowdfunding
Here are the pros and cons of crowdfunding:
|Pros of crowdfunding||Cons of crowdfunding|
|Money may not need to be repaid||Potential failure to meet goals and not receive money|
|Funds often come from many investors||Fees can be steep|
|Build a customer base early||Your business idea may get swiped|
|Likely no credit check||Time requirements may be significant|
|Possible feedback channel||You may not have as much guidance|
|Avoid high cost of a business loan||Federal restrictions on how much you can accept from individual non-accredited investors|
|You can take money from non-accredited and accredited investors||Transactions must take place via a U.S. Securities and Exchanges Commission-registered broker or funding portal|
|You can choose cost-effective incentives to lower your reward expenses||CPA must review your finances if raising above $107,000|
|Quickly raise a significant amount of capital||Giving up equity in your company may potentially impact your budget|
There are several key potential advantages to crowdfunding for your business. Consider these pros when deciding if crowdfunding could make a good supplement to or replacement for business loans.
May not need to pay the money back
The primary advantage of equity, reward and donation-based crowdfunding is that you don’t have a monthly loan payment. But you may have to surrender equity in your company to earn crowdfunding contributions. Businesses may choose to crowdfund over loans to avoid worries about defaulting.
That said, if you opt for debt-based crowdfunding, you will have to repay supporters.
Funds come from many investors
Instead of putting all your eggs in one basket, crowdfunding opens up more funding sources. Some businesses get funds from hundreds or even thousands of donors. This may be preferable to seeking money from a single source when the market is not favorable to granting new loans.
Build a customer base early
Because investors are also learning about your business in the early stages, your crowdfunding investors may also become loyal customers. You can build a contact list as you collect donations.
Likely no credit check required
Typically, crowdfunding platforms don’t run credit checks, so there’s no impact on your personal or business credit score. But when choosing debt crowdfunding, this type of alternative lending likely will include a credit check since it is a loan from multiple investors.
Possible feedback channel
You may be able to solicit some feedback from your donors. Equity donors are especially likely to be open to providing feedback on a business plan or prototype because they have a literal stake in your company’s success.
Crowdfunding for business doesn’t mean sitting back and receiving free money. Sweat equity and stress go into the process, too. Here are some potential crowdfunding disadvantages.
Potential failure to meet goals
Crowdfunding platforms commonly require businesses to return all funds to donors if they don’t meet their fundraising goal. As of May 2023, only 40 percent of crowdfunding campaigns on the popular platform Kickstarter achieved their goal.
Fees can be steep
On Kickstarter, for instance, you must pay a fee of 5 percent of all donated funds on top of payment processing fees that range from 3 percent to 5 percent. But fees only apply to successful campaigns. You also have platforms like GoFundMe that don’t charge a fee for donations, but the payment processing fee is 2.9 percent.
Your business idea may get swiped
Creating a crowdfunding site also means advertising your business at its earliest stages. A business that has not copyrighted or patented its idea could risk having it stolen. If an imitator beats you to the market, your business may suffer.
Time requirements may be significant
Successful crowdfunding requires bringing awareness to your campaign. You may spend a lot of time on social media drumming up interest in your fundraiser. Plus, the process isn’t fast. Many businesses must wait for months for their campaign to be fully funded and then receive their funds.
If you need money soon, a small business loan might be the better option. Once you complete an application and provide the requested business loan documentation, funding can happen within a week, depending on the lender. But there are alternatives to a business loan and crowdfunding, including a business line of credit or a business credit card with significantly shorter time requirements.
You may not have as much guidance
While investors can have useful advice, you won’t have a formal loan advisor like many lending institutions offer. If you want help navigating the crowdfunding process, you’ll have to seek it outside the platform you use.
The bottom line
Crowdfunding can be a savvy way to raise initial funds for your business, especially if you are having a hard time getting approved for traditional funding. Just make sure to pay attention to any federal regulations and crowdfunding platform rules. And invest in marketing — you will see limited donations if people don’t know about or understand your business.
Frequently asked questions about crowdfunding
Yes, you can use crowdfunding to raise capital to fund your business startup or a specific project for your business.
When using crowdfunding to raise money for your small business, you determine your idea, goal and timeline, select your funding platform, launch and share your campaign and collect donations. When the campaign ends, you can follow up with your donors and contributors to provide any rewards you may have promised.
Crowdfunding may not be as risky as a loan, but with this type of funding option, you risk not raising the capital you need or someone swiping your business idea. Your credit score could also suffer if you opt for debt crowdfunding.