Should You Crowdfund Investments for Your New Business?

Should You Crowdfund Investments for Your New Business?

New entrepreneurs — no matter their age or level of business experience — have to sit down and do two things at some point before they can get their venture off the ground: create a business plan and raise funds. Unless you’re self-funded and crazy enough to wing it without a business plan (good luck!), then at the very least you’ll need to outline your business strategy to ensure it makes sense on paper. You’ll also have to consider what options you have for raising funds for your business, along with the pros and cons of each.

Fortunately, today’s entrepreneurs have more options than ever when it comes to financing. The best options for the type of financing you choose will depend on the type of business you want to launch and how well you’re currently sitting financially.

One of the biggest recent developments in small business financing has been the rise of crowdfunding platforms to help small business owners infuse new capital into their businesses. Here are some ideas on small business crowdfunding, including how it works and the pros and cons of this relatively new investment strategy.

When Is Crowdfunding a Good Idea for New Businesses?

There are a few reasons you should consider using crowdfunding for your new business. Unless you are an existing company with broad brand awareness, crowdfunding is a great way to get the word out about your business to prospective fans. With the power of social media, you can build grassroots support for your idea through Facebook and Instagram, as well as the platform websites themselves. Many potential small-dollar investors search Kickstarter and Indiegogo for cool new gadgets, food products, artwork and many other innovative ideas that bigger companies might not be pursuing yet.

Crowdfunding is also a great way to test the market and build financial support for a specific new product — such as a new invention, a new tech device, a new variety of food or beverage and other ideas that need some upfront capital to help develop the product and bring it to market. Crowdfunding, at its best, can be a kind of “co-creation,” where you work with your audience of potential customers to bring a new business idea to life.

For example, you can set up incentives and offer “prizes” or premium memberships to people who help fund your business idea. Lots of people love to get in on the ground floor with a new business idea, and by giving people an exclusive experience (invitations to a launch party, free taste tests of your new food product, etc.), you can build relationships with your buyers and investors while building your business.

Crowdfunding Can Build Buzz

If you have social media skills (or a team that can execute and promote your idea on these platforms), crowdfunding could be a simpler way to get your idea into the hands of the people who will use it. Most importantly, it can help get the word out to others through their own social networks and/or existing positive reviews.

You should definitely try to build these types of re-marketing strategies into your incentives to invest. This could be as simple as including a thank you card with a customer’s reward that encourages them to help get the word out about your new product or business. You can also give referral bonuses to your most passionate customers who help spread the word to their friends. Everyone loves to help the little guy, and it never hurts to thank the folks who supported you from the ground up!

Crowdfunding Can Be Easier Than Bank Loans

Many entrepreneurs love crowdfunding because it’s so simple to request and receive funds, compared to going through traditional finance channels. When you ask for any size business loan from a lender (whether it’s a bank or an individual investor), you’ll likely need to fill out lengthy loan applications and provide lots of paperwork to prove your creditworthiness. In this situation, you’re basically trying to prove the worthiness of your new business idea to someone who may not ever be a real customer — and even then, you still might not get approved for the loan.

In many cases this makes sense. After all, if you want to open a hair salon, you should be licensed, have good credit, understand the risks and pitfalls and have outlined a realistic budget and forecast. However, many small business owners operating online discover that the traditional world of bank loans doesn’t know how to handle them. If you don’t have a brick-and-mortar business or a traditional retail storefront, a bank loan officer might not understand your value proposition and may decline your loan application.

This is another reason that crowdfunding can work well for small businesses: it’s simple and direct. You go straight to your audience of friends, relatives, fans and followers on social media, and ask them for financial support.

However, keep in mind that even if you can raise funds without the traditional risk assessments of a bank loan, you still need to be conscious of risk. In the excitement and stress of organizing the launch of a new business, it can be easy to put on rose-colored glasses and overlook the financial commitment it will really take to execute your vision. Just make sure to do your own due diligence and follow the traditional steps of outlining your business objectives and organizing your financials, no matter what your investors require from you.

Crowdfunding Minimizes Financial Risk

When you receive a loan from a bank or an investor, there is either a clear expectation for repayment or a level of anticipated return on the investment from the party who provided funds. Don’t ever forget that an investment isn’t a gift; investors expect to earn a return on their money, which can sometimes lead to tensions and disagreements between the investors and the business owner.

Many entrepreneurs enjoy crowdfunding because it immediately pays for producing the first iteration of your product or service while boosting your chances of gaining a foothold and growing from there. All of this is without the ongoing obligations to investors that giving up an equity share in your business would entail.

Even in the unfortunate case that your business doesn’t reach its crowdfunding goals, this situation is still often preferable to disappointing an investor or defaulting on a loan. When you don’t reach a crowdfunding goal, you can step back and analyze what went wrong without being on the hook for thousands of dollars to a bank. Maybe your idea is solid, but the crowdfunding campaign was poorly executed. Maybe you chose the wrong platform to launch. Or maybe you need to tweak your product or service to make it more appealing to a broader audience.

Cons of Crowdfunding Your Business

Crowdfunding has its downsides, too. Failure to plan and execute a great crowdfunding campaign might undermine your chances for success. Don’t rush into it thinking that crowdfunding will be an instant cure-all for your financial needs, and don’t assume that you can do crowdfunding for free or cheap. Many startups spend a lot of money and time creating great videos and websites to sell their ideas and supplement their crowdfunding campaigns.

You also need to be sure you can deliver what you promise for your backer incentives and do so as close as possible to the deadlines you promoted in your campaign. The last thing you want to do is upset the people who funded your business by delaying delivery or sending a less-than-stellar product. Crowdfunding is a great chance to build closer relationships with your best customers — but if you fail to keep your promises, you risk damaging these important relationships with your inner circle. It’s best to under-promise and over-deliver!

Is Crowdfunding Right for My Business?

If you want to determine whether crowdfunding is the right way to raise capital for your business, start with a competitive analysis of your industry. Look at what your competitors are doing — you might be able to emulate a similar crowdfunding campaign with your own voice and style.

Also, compare crowdfunding platforms to determine which is best for your product; there can be big differences between the audiences of each crowdfunding site. Some crowdfunding sites are more about raising donations for charitable causes, while others are truly investment-oriented and can help you find a bigger audience of early adopters who are enthusiastic about funding new businesses.

And finally, ensure crowdfunding actually makes money for your business! Crowdfunding should not be a “loss leader;” you need to ask for enough money from crowdfunding to make a profit, even after all the incentives have been given away.

Ideally, your crowdfunding campaign should give you strong momentum and a big financial cushion to help invest in the next phase of business growth on your own. It’s a great idea to make a mini-business plan for your crowdfunding campaign, including a marketing plan for how to promote your crowdfunding page (social media, PR, sponsored social media posts, etc.), and a financial analysis to understand how much money you want to raise, how many products you can produce and the profit margin for each. If you know what to expect, understand the risks, and have a clear vision of what success looks like for your business, you’ll be able to go into your crowdfunding experience with more confidence.

Are you ready to start a business, form an LLC, or reorganize your business structure to have a “real” legal business entity to build credibility with investors? Talk to Incfile today! Our incorporation experts can help you evaluate your options and move forward with confidence.

Ben Gran

Ben Gran is a freelance writer from Des Moines, Iowa. Ben has written for Fortune 500 companies, the Governor of Iowa (who now serves as U.S. Secretary of Agriculture), the U.S. Secretary of the Navy, and many corporate clients. He writes about entrepreneurship, technology, food and other areas of great personal interest.