When a great many people come together, each putting a small sum forward, thousands worth of financing can be gained. This is what crowdfunding is, and it usually starts with an open call on social media.
Anyone who is interested can contribute, and all donations or investments are used towards a clearly defined goal. This goal could be an object that needs to be bought or a project that needs to be completed.
Starting with Crowdfunders
Crowdfunding is very different from the more traditional forms of financing a startup.
It involves working with a large group of mostly small investors, and this can be a challenging process.
Investors, also called crowdfunders, may expect a reward for their investment in the form of a small gift, interest, or a share in the profits.
Some crowdfunders may want a say in important decisions.
The way crowdfunders are rewarded is fundamental in deciding which type of crowdfunding a startup wants to get engaged in.
Choosing the Right Type of Crowdfunding (for Your Company)
Four major types of crowdfunding have emerged in the last few years:
- donation based
- reward based
- lending based
- equity based
Donation-based crowdfunding is a type of crowdfunding where investors donate a sum of money without expecting anything in return.
In reward-based crowdfunding, on the other hand, crowdfunders receive a small gift in return for their contribution.
This could be tickets to a show, for example, or a book, or a first edition of a released product by the company. What is important here is that the gift is a tangible item and it’s a one-off deal.
A third type of crowdfunding is called lending-based crowdfunding.
Here crowdfunders receive a periodical payment until the whole investment is repaid.
And in equity-based crowdfunding crowdfunders receive a share of the profits. In short, they have a stake in the company.
Proving Viability with Crowdfunding
In today’s economic climate startups can have a hard time proving to potential investors that their idea is viable, and hence financing can be almost impossible to obtain.
With crowdfunding however, companies not only have the chance to gain the financing that they so desperately need, they also get to see just how viable their idea really is.
Just think about it. What better way to find out if a business has something valuable to offer the market, than by asking the market to invest in the business?
A successful crowdfunding campaign may say more about the viability of a company than market research ever could.
The crowdfunders are the market; they are the ones who will be buying the product or service, so it could be said that their investment proves the need for what the company offers.
In the startup-o-sphere and lean startup methodology, crowdfunding can be likened to the product validation phase, where you are offering your Minimum Viable Product on the crowdfunding platform to test the demand and salability of an idea. The success of your campaign, or not, would be the validated learning.
There are even startup accelerators that use crowdfunding as part of their process to test the market for further investment and growth, Brinc, a Hong Kong based Internet of Thing (IoT) focused accelerator is a prime example.
Having said that, no matter how successful a crowdfunding campaign is, it is still no guarantee that the company will succeed. That kind of guarantee just doesn’t exist in business.
Deciding on Social Importance
Crowdfunders generally think a little different than traditional investors.
For most crowdfunders a so-called social return on investment, or SROI, is an important impetus. But to what extent social motives can overrule financial gain is a question that is hard to answer.
Sometimes, if the required investment is small, expectations of a financial reward may be non-existing.
When social motives are strong it could direct the company towards of new type of shareholdership, one where members are shareholders.
Imagine if Facebook had sold all its shares to members instead of institutional investors. Would the shares have lost their value as quickly, or would the members have taken more of a long-term view?
(The Possibility of) Getting Follow-up Financing
Startups that use crowdfunding as a means of finance are quick to learn that many of their investors are closely involved and that they expect regular updates of how the company is doing.
Getting involved in crowdfunding is a big responsibility for a company, but by maintaining good relationships with investors chances of receiving more investment down the road increase greatly.
As the total amount of investment grows, crowdfunding increasingly becomes a viable alternative to other forms of financing, such as subsidies, loans, and angel or venture capitalist investment.
At a time when regulations surrounding subsidies and bank loans for startups have become more stringent, crowdfunding is a welcome addition to the financing-option pool. Even better, there are now, in 2017, many ways to grow your business and get your product(s) distributed once your crowdfunding campaign has ended.