So you have a great idea for your startup, but you’ve already drained your savings to get your business off the ground. Now, it’s time to start looking into ways to raise capital, so you’re considering crowdfunding pros and cons compared to other options, like pitching to investors from venture capital firms or applying for a loan.
Crowdfunding can be a good fit for certain ideas, or it can supplement other forms of raising money. It’s also attractive if you’re new to the startup industry and aren’t sure how to navigate series funding or loan applications.
But crowdfunding isn’t always the best option for startups, especially if you have a disruptive idea.
Let’s dive into the pros and cons of crowdfunding, so you can determine whether it’s right for you.
What is Crowdfunding?
Crowdfunding is the process of collecting money from the public to help fund a business or a new idea. This can be an alternative or a supplement to other forms of raising capital for a startup, such as going through series funding or applying for a small business loan.
There are four main types of crowdfunding:
- Rewards: Rewards crowdfunding offers supporters perks like merchandise, discounts, or bonus digital content in exchange for their financial support.
- Equity: With this type of crowdfunding, you can offer equity, or a stake or piece of ownership, in the company in exchange for capital.
- Donation: Donation crowdfunding collections donations from supporters with no expectation of any perks, equity, or repayment in return.
- Debt: With debt crowdfunding, supporters provide you money upfront, which you will repay with interest later on.
The type of crowdfunding a business pursues depends mostly on the type of business and its goals. A charitable organization will likely rely on donation crowdfunding to raise funds to support a cause or initiative, while a company that wants to launch a new product may use rewards crowdfunding to offer early access or discounts to supporters who fund the idea.
Crowdfunding Pros and Cons
No matter what type of crowdfunding you want to pursue, there are crowdfunding pros and cons that startups need to consider. While this can be a way to raise money quickly and generate excitement about your brand or latest idea, crowdfunding is still a lot of work subject to restrictions, and it makes your idea vulnerable to being swiped by someone else.
Crowdfunding Pros
For startups, crowdfunding offers many benefits, especially if you’re not familiar with raising capital or you don’t have a strong credit history or credit score. It’s also a great way to build strong connections with your target audience.
1. Build an Engaged Audience
When you’re pitching to investors, these individuals may or may not be in your target audience, and they don’t have to want to buy the product to believe it’s a good idea worth investing in.
But with crowdfunding, supporters may be paying for discounts, early access, or other perks that set them up to be future customers as well as investors in your brand.
2. No Credit Score Required — Usually
If you want to apply for a business loan, you’ll need to provide your credit score and history to determine if you are eligible. But crowdfunding offers a way to raise capital without providing this information (unless you set up a debt crowdfunding campaign, in which case, you should expect a credit check).
3. Raise Money Quickly
Crowdfunding platforms have a limit, often 60 days, for a crowdfunding campaign. Most successful campaigns happen within even shorter timespans, 30 to 40 days.
This is a much faster way to raise money than through series funding, which takes about 12 to 18 months just for Series A funding. Obtaining a small business loan, which takes time to provide documentation to apply, takes about 30 to 90 days to receive the loan, but can take up to 6 months to receive the funds once approved.
4. Able to Maintain Equity
If you opt for rewards, donation, or debt crowdfunding, you can maintain full equity of the startup. When you seek out an angel investor or go through series funding, you may be exchanging part ownership for the investor’s initial capital in your business.
5. May Not Face Repayments or Interest Fees
Depending on the type of crowdfunding you choose, you may not have to repay or pay interest fees like you would on a business loan or to an investor. Donation crowdfunding campaigns come with no supporter expectations to be repaid, to receive equity or other perks, and rewards crowdfunding offers other incentives like brand merchandise or exclusive content.
However, if you opt for equity or debt crowdfunding, you will need to offer an ownership percentage to supporters or repay their pledges, plus interest, in the future.
6. Campaigns Can Double as Marketing
While you’re putting together a well-researched and exciting campaign to get potential supporters excited enough to donate to your mission, you’re also simultaneously creating marketing materials. You’ll want to put together press releases to get the word out about your campaign, but at the same time, this helps generate more attention about your brand and upcoming product or service.
7. Funding Comes From Multiple Investors
As a startup founder, you may be concerned about offering a larger percentage of company ownership to a few high-paying investors. With crowdfunding, you’re collecting capital from a much larger audience, and you may not even be offering equity to these investors. This can give you peace of mind if maintaining as much control over the company as possible is important to you.
8. Can Gather Feedback From Supporters
When you’ve shared your latest product idea or upcoming service via a crowdfunding campaign, supporters can ask questions and give feedback before you’ve started manufacturing the product or service. This can allow you to tweak your idea to better serve customers in the future.
Crowdfunding Cons
Crowdfunding does have its limitations, though. Because you’re marketing the product and pitching for investments at the same time, it’s a lot of work from building the campaign to following through on rewards or repayments after your campaign ends.
1. May Not Raise as Much as Series Funding or Loans
Crowdfunding can raise money quickly, usually within a month, but the amounts you will receive from crowdfunding are typically lower than what you could earn through series funding or a loan.
Donation crowdfunding campaigns make an average of $9,000, and successful crowdfunding campaigns of any type raise an average of $28,656. By comparison, the first stage of series funding alone, called seed funding, raises about $3.6M on average, and the average small business loan is about $663,000.
2. Idea is Open to the Public
If you have an idea that could disrupt your industry or fulfill a unique need, plastering that idea online to raise money makes you vulnerable to having your idea stolen. Make sure you’ve protected your intellectual property, such as by registering for copyrights or trademarks, before you start crowdfunding.
3. Crowdfunding Isn’t Always Trusted by Supporters
Many everyday people have been burned after investing in a crowdfunding campaign they were excited about, only to never receive the rewards they were promised. On Kickstarter alone, about 9% of successfully funded projects don’t deliver the rewards they offered to supporters.
What does this mean for a startup hoping to crowdfund its next idea? Well, supporters may be wary if you’ll truly deliver on your rewards. To combat these concerns, make sure your rewards are realistic and that your company has the funds and time to deliver rewards as promised. Also, be transparent by communicating with supporters via your campaign page regularly as the campaign progresses.
4. Requires as Much Work as Pitching Investors
When you want to find angel investors or get capital through series funding rounds, you need to do a lot of work to finalize a business plan, create a pitch deck, and prove that you not only have a unique idea but that it has standing power to last years into the future. You still need to do that work when preparing to crowdfund if you want to have the best chance of securing pledges. At the same time, you’re preparing marketing materials for the product or service, since supporters could be potential customers.
5. You’ll Need to Pay Platform Fees
When you use a platform for crowdfunding, your crowdfunded earnings are subject to that platform’s fees. Most crowdfunding platforms charge a fee ranging from 5% to 12%, but you may also see a flat percentage fee on total earnings plus another fee for each pledge. For example, platforms like Fundly, Indiegogo, GoFundMe, and Kickstarter have percentage fees, plus processing fees of about $0.30 per pledge.
6. Must Follow Federal Regulations
As with any method of raising funds for a startup, crowdfunding must follow federal regulations. For example, the Securities and Exchanges Commission (SEC) requires crowdfunding to go through a SEC-registered intermediary, like a funding platform or a broker-dealer.
There are also limits to how much money a business can raise through crowdfunding every 12 months and how much a single investor can put into crowdfunding campaigns collectively per 12 months. Regulation crowdfunding allows a business to earn a maximum $5 million across the company’s collective crowdfunding campaigns in a 12-month timeframe.
7. Failure Is Highly Visible
Crowdfunding is more often unsuccessful than not. In fact, about 60% of crowdfunding campaigns fail to secure enough money to fund the mission. When you’re raising funds publicly, that means you’ll be failing publicly, too.
Not only that, but many crowdfunding platforms return donations to supporters if a campaign doesn’t meet its financial goal within the set timeframe.
8. May Be Offering Up Equity to Many Supporters
If you decide to pursue equity crowdfunding, you could be offering up small shares of equity to a wide range of supporters. This can be beneficial if you don’t want more power going to a few investors, but it can also impact your budget long-term if you’re sharing equity with a larger number of supporters.
Is Crowdfunding Right for Your Startup?
Each startup needs to weigh the crowdfunding pros and cons to determine whether this method of raising business capital is a good fit.
If you want to raise money quickly, you want to skip credit checks, or you want to generate buzz for your product or service, this might be the right path for you to take.
However, if you need to raise a high amount of investments to get your idea off the ground or your concerned about idea theft, crowdfunding may not be right for you. Crowdfunding doesn’t have to stand alone, either.
You may be able to incorporate crowdfunding as one method in your journey to raising capital. Just be sure to work through the benefits and drawbacks of all of your options before making a final decision.
