Pros and cons of crowdfunding for business
The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .
Starting or expanding a business often requires getting a bank loan. But, there may be a viable alternative if you don’t qualify. Crowdfunding allows you to raise funds for your endeavor without going through traditional lenders. With crowdfunding, also called crowd financing, a collection of individuals will pool their money to support your business.
Why would friends and strangers pitch in like this? Usually for equity or another reward. Crowdfunding for business is not just popular, but a growing market. In fact, the global crowdfunding market is expected to reach more than $5.5 billion by 2030.
Read on to learn more about crowdfunding pros and cons, as well as the most common types of crowd financing.
- 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
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.
No 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. That being said, you may have to surrender equity in your company to earn crowdfunding contributions. Businesses may choose crowdfunding over loans to avoid worries about defaulting.
If you opt for debt-based crowdfunding, of course, 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.
No credit check required
Unlike traditional loans, crowdfunding platforms don’t require credit checks or collateral. This could be beneficial to business owners who don’t have a long operating history or stellar personal or business credit.
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 the success of your company.
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 November 2022, only 40 percent of crowdfunding campaigns on the popular platform Kickstarter were able to achieve their goal.
Fees can be steep
You will avoid interest payments by going the crowdfunding route, but you can’t escape all fees. 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. These fees only apply to successful campaigns.
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 loan might be the better option.
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.
Types of crowdfunding
There are several types of business crowdfunding. Two of the most common are reward- and equity-based funding, both of 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.
- You can take money from non-accredited and accredited investors
- You can choose cost-effective incentives to lower your reward expenses
- You may receive no funds at all if you don’t meet your goal
- Many reward-based fundraisers are met with great interest, but small donation amounts because the investor is not getting any equity
- Some crowdfunding websites for reward-based fundraisers have significant fees
- You’ll risk serious reputation damage if you fail to deliver promised rewards on time
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, there are strict federal and state filing requirements that must be completed once your funding period concludes. Wefunder is one equity crowdfunding platform.
- You can avoid costly small business loans
- You may raise a significant amount of capital quickly
- Federal restrictions on how much you can accept from individual non-accredited investors
- Transactions must take place via a U.S. Securities and Exchanges Commission-registered broker or funding portal
- Must have a CPA review your finances if raising above $107,000
- You’re giving up equity in your company, potentially impacting your budget
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.