Many are the entrepreneurs who have lamented, “If only I had the money to start my enterprise.” For startup businesses experiencing difficulty—and often exasperation—trying to get financing via traditional means, crowdfunding offers an alternative.
Like The Local, a Prescott restaurant featuring locally sourced produce and meats, crowdfunding can be an effective way to raise capital—and public awareness—when launching or growing a small business. Rather than approaching a single lender to make a significant loan to your business, crowdfunding platforms give you a way to leverage your network of friends, family, social media connections, and the public at large to obtain significant capital in small increments. However, like the entrepreneurs who launched The Local found, it can take rethinking, coming up with a portion of the needed financing yourself, lowering expectations, and more than one attempt to raise the necessary capital.
Crowdfunding is a collective online effort that can not only expand your professional network but introduce your business to potential customers. The Local has grown, has a steady clientele, and is a successful business, with the start-up help from Kickstarter.
Crowdfunding for businesses presently comes in three primary forms:
- Rewards-based crowdfunding (such as via Kickstarter and Indiegogo)
- Equity crowdfunding (such as via CircleUp)
- Peer-to-peer lending (such as via Lending Club)
Unlike rewards-based crowdfunding, equity crowdfunding and peer-to-peer lending are governed by a complicated web of federal and state securities laws, while rewards-based crowdfunding is generally exempt from those laws, so this article focuses on rewards-based funding.
According to SCORE mentor and Portland Maine business attorney Chris Dargie, rewards-based crowdfunding has rapidly become an accepted way to raise capital for small businesses.
“Traditionally, companies raised capital by issuing debt or equity,” said Dargie. “Rewards-based crowdfunding introduced a completely new alternative. The model has shown that the public is willing to contribute capital to worthy projects without any expectation of future profit, which is quite revolutionary.”
To help make a rewards-based crowdfunding effort successful, Dargie offers these dos and don’ts:
• understand the differences between rewards-based crowdfunding, equity crowdfunding, and peer-to-peer lending. With rewards-based crowdfunding, you are only promising your backers some sort of token incentive and the risks are more limited. The Local provided different rewards such as an introductory meals and signing the back wall of the restaurant.
With equity crowdfunding, the risks can be substantial. With peer-to-peer lending, the business is taking on debt that it is legally obligated to pay back.
• pick the right platform for your rewards-based campaign. Don’t automatically default to Kickstarter or Indiegogo, as there may be better options. Crowdfunding is a form of marketing, and you want to be where your customers are.
• follow through on your promises. Watchdog groups and state and federal consumer protection bureaus have begun to shift their attention to deceptive crowdfunding campaigns. “There is an inherent risk of consumer fraud in these campaigns,” said Dargie, “and businesses should be prepared to deliver on their commitments if they want to minimize their risk of legal liability.”
• fail to manage the expectations of your campaign’s backers. Delays in business are a fact of life and usually only become a problem when the company fails to keep its backers in the loop.
• launch a campaign without the liability protection of a properly formed business entity. “You don’t want to be left holding the bag personally if your business has spent all the money on development and has nothing to show for it at the end, and the backers want their money back,” said Dargie.
• forget about taxes. Proceeds raised from rewards-based crowdfunding campaigns are usually treated as taxable income to the business. For this reason, Dargie advises businesses to consult with their tax advisors before embarking on a crowdfunding campaign.