Crowdfunding has become an accepted process for startups and entrepreneurs to raise money for an idea, project, or entire business. It has successfully combined the concepts of crowdsourcing and microfinancing in a way that can complement or substitute traditional forms of financing, like angel investing, venture capital, and bank loans. However, with so many different crowdfunding platforms and models to choose from, it can be difficult for startups to choose the right one that will effectively help their business.
This article will take a closer look at the different types of crowdfunding and the pros and cons that come with them so that businesses out there can clearly understand which one works for their intentions.
1) Reward-Based Crowdfunding
This crowdfunding method is perhaps the most popular and comes in platforms like Kickstarter and Indiegogo. Through reward-based crowdfunding, people can pledge money to creative projects, new pieces of technology, or any other product or service. What makes it so effective is that donors who fundraise for projects on the platforms receive incentives or rewards when they donate their money to worthy projects or companies.
While it may seem simple enough to post a project online, much effort goes into it before it can successfully gain funding. Getting thousands of people to donate to a project requires the same if not more attention, planning, and execution as any other successful marketing or fundraising campaign.
On platforms like Kickstarter and Indiegogo, they assist HOW and WHERE to post things, but everything else is up to the company. From steps like setting funding goals to devising a reward strategy, posting their campaign, using social media platforms, and delivering the rewards, companies need to have a clear image of where they want their fundraising to lead.
Pros & Cons
By using the rewards-based approach, companies do have access to “cheap money.” Companies can raise money for their project or business without selling an equity stake in their business. The money they receive is considered donations, and if the campaign goes well, they can get thousands of people who genuinely believe in the company, their product, and the success of the campaign. Also, through rewards-based crowdfunding, companies can lay the groundwork for their next project because they have already built a network of engaged, enthusiastic supporters who already believe in the company’s work. If they had a good experience, they would be more than willing to get involved in the next project.
However, the disadvantages to this are that with the amount of money raised and donors waiting for their rewards to be delivered, the pressure is on to deliver them in a timely fashion. Otherwise, donors will get disgruntled that they are not receiving what they were told they would when they would. Secondly, given the nature of some crowdfunding campaigns, companies may have spent a lot of time and energy running a campaign that fails because they cannot hit their funding goal and receive nothing. Of course, some platforms like Indiegogo also allow flexible funding where companies can get the amount of money they could raise by the time the fundraising time has ended. Even so, there’s still a possibility that it may be a lot less than they expected.
2) Equity Crowdfunding
While rewards-based crowdfunders make donations in exchange for rewards and the pure satisfaction of helping companies achieve their goals, equity crowdfunders provide companies with working capital in exchange for a piece of the company. Usually, to get a business off the ground or provide it with capital, entrepreneurs tend to turn outside investors to get additional money.
Equity crowdfunding allows investors to participate in partial ownership of a company because they each individually get a stake in the company and a percentage of the profits. This can be beneficial to startups because it is a quick way to gain access to capital, but it can get complicated when it comes to legal regulations. Because it allows for a large number of equity investors into a business, the business’s original owners may lose some power.
Pros & Cons
While taking angel investing online, equity crowdfunding is innovative because it has opened up this investing to more people. These people are very accomplished investors who use crowdfunding platforms to add to businesses’ success in the long term. Secondly, there is a potential for more considerable sums of fundraising, which would not be obtained with small donations. Along with that, it creates more accessible investor relations because rather than raising money from numerous investors, some equity crowdfunding platforms gather all the funds they raise into a single investment, making only one point of contact.
While this shouldn’t be considered a con, not all entrepreneurs are entirely comfortable with posting their financials and business plans online for investors to see. Equity crowdfunding forces startups to increase transparency and be comfortable with presenting their information to potential investors. Secondly, it is also expensive fundraising because startups are quite literally giving away a piece of their company without knowing if they are getting something valuable in return.
3) Donation-Based Crowdfunding
GoFundMe is an excellent example of a platform that uses donation-based crowdfunding. This type of crowdfunding is usually used by non-profits seeking donations to raise funds for their causes. Most contributors who donate money through these platforms do not usually expect anything in return and contribute to a cause or organization that they support. In all cases, the ROI (return on investment) comes from personal satisfaction gained from contributing to a project.
This type of crowdfunding is suitable for those financing charitable cases or supporting an individual or group to impact a community or society.
Pros & Cons
Crowdfunding is never easy, and generally, with donation-based crowdfunding, there is a real possibility that a project will get lost in the sea of others trying to compete for the same attention. But, people are happy to support a charitable project, and there is already a pretty captive market of donors who prefer to give their money to a worthy cause. Secondly, there are no shareholders to report to and no potential loss of control. Finally, this type of crowdfunding is a great way to build a winning PR strategy. With so much happening in the world, many people are driven more by purpose than profit. Recent studies have shown that businesses that have a strong mission statement driven by the desire for change are the ones that gain the most traction.
Companies using donation-based crowdfunding may think that just because they are a non-profit, they can be forgiven for mishaps. On the contrary, there is an increased scrutiny level because donors to non-profits still expect the same management skills and expertise, and transparency as other businesses. Regardless of whether they use this type of crowdfunding, it is still wise to have a high level of openness, transparency, regular communication, and accountability. Secondly, to stand out and succeed in such a saturated market, many businesses have had to endure administration costs and become Certified B Corps, Social Enterprises, or Public Benefit Corporations to build substantial credibility in the community.
4) Peer-to-Peer Lending
Long ago, peer-to-peer lending meant asking for a small amount of money from loved ones to fund a business. However, these days, platforms like Lending Club and Prosper have emerged to apply that same concept to crowdfunding. This enables startups to get access to funds outside of the traditional loaning channels.
Pros & Cons
Peer-to-peer lending can provide significant advantages to both the startup borrowing the money and lenders because it generally provides higher returns to investors relative to other investment types. Secondly, it gives borrowers a more accessible source of funding than conventional loans from financial institutions. Along those same lines, P2P loans usually come with lower interest rates because of the greater competition.
Even so, P2P loans are also exposed to high credit risks because many apply to possess low credit ratings that did not allow them to get a loan previously. Secondly, there is no insurance or government protection to the lenders in case of the borrower’s default. Finally, some jurisdictions and legislations do not allow P2P lending or require companies to provide such services to comply with investment regulations.
Whatever type of crowdfunding a startup chooses to use, they need to make sure that they understand which one fits with their needs. Crowdfunding has become successful through sites like Kickstarter and Indiegogo. However, there are still plenty of platforms out there for startups that decide to look to ones that may not already be fully saturated with projects ranging in different categories. Either way, startups need to create an effective marketing plan with valuable content and a great product to get the traction they need.
Either by themselves or with the help of PR agencies like Pressfarm, companies can not only get help creating content but also get a better understanding of the digital landscape of crowdfunding. Pressfarm helps startups and entrepreneurs create newsworthy content from press releases to media pitches and guest post articles. Their extensive PR database of over 75,000 journalists is the perfect tool for companies to find their ideal media match. Additionally, they also help increase the online visibility of brands by helping them feature in relevant search results on various search engines. With the help of experts, companies can navigate through the sea of crowdfunding campaigns with ease.