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Neil Patel

I hope you enjoy reading this blog post.

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Are you wondering what are the pros and cons of crowdfunding?

Crowdfunding can be a fantastic way to raise significant sums of money to get your startup or business idea off the ground and to the next level.

There are also some downsides which many first-timers overlook. Know the pros and cons and make an educated choice before you rush in or dismiss this as a fundraising option.

There are different forms of crowdfunding as seen in the picture below. Over this post, I will cover some of the pitfalls and some of the advantages of going either way.

Pros And Cons Of Crowdfunding

The Pros Of Crowdfunding Capital For Your Business

1) Getting Right To The Investors

One of the biggest challenges in trying to raise startup capital is finding and connecting with investors. If you don’t already have a great database and strong relationships this can take a lot of time. 

You can go back to business school for a couple of years and build a network. You can go out to every event possible and develop a network over time. You can try to apply to startup accelerator programs. Though they can be harder to get into than Harvard. You can tap your friends and family. Or you can get a fundraising consultant who already has all the connections and relationships you need. 

This last option is similar to crowdfunding, where you can leverage an existing online platform, which already has a database of investor users. Put up your campaign and get right in front of a pool of active investors who are looking for opportunities to fund. You can shave months and years off of knocking on doors and flying across the country.

This was exactly the case when Obama signed the JOBS Act in 2012, allowing everyone to invest in startups as opposed to just accredited investors which only represent 1% of the US population. 

Pros And Cons Of Crowdfunding

2) Quick Proof Of Demand

Once all of your materials are ready you can launch your crowdfunding campaign online and pretty quickly see if you were right about the demand for your solution and your investment offering.

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There may be an extra step or two in going the crowdfunding route. You’ll need to create a campaign page, etc. Though in a few days or at least a couple of weeks you’ll know whether there is an appetite for this, or you were completely off track.

3) Extra Buzz & Visibility

Crowdfunding campaigns can be great for generating extra buzz and press. They give you something newsworthy to publish about on the typical media outlets like Techcrunch or even The Wall Street Journal. They give others something newsworthy to publish and write on and share. This can all do wonders for your startup business, even if you don’t get all the money you expected through the initial campaign and platform you chose.

4) Gain Many Backers

As shown above, in the picture, there are a variety of types of crowdfunding campaigns. They include equity, debt, and donation-based crowdfunding. 

You are more likely to pick up a larger number of investors with these campaigns. One of the pros of this is so many more people invested in your success.

They’ll want to shop with you, tell their friends, family, and coworkers about you, and help share. They become brand ambassadors for both raising money and selling your solution. 

5) Creating Urgency

One of the big problems of stomping around trying to cold pitch investors is the lack of urgency and fear of missing out. You appear desperate. They are doing you a favor if they choose to invest anything with you at all.

When you have a public crowdfunding campaign, this is all very front and center. Providing you keep up the momentum of adding funds, and clear end date for the round, it changes the dynamics. Now investors are lucky to be able to participate. Now they are competing to get in and give you their money. It becomes urgent for them. 

This is also a smart way to extend your rounds and make sure they are oversubscribed and you have the advantage in negotiating and setting the terms. Without a doubt when you are thinking about the pros and cons of crowdfunding remember that fear of missing out and urgency will push people over the edge to give you money. 

The Cons Of Crowdfunding Capital For Your Business

If you are choosing equity crowdfunding the biggest hurdles by far are the ones outlined in the picture below.

Pros And Cons Of Crowdfunding

These hurdles were initially introduced with the implementation of the rules outlined by the Security and Exchange Commission. Over time some of them have been amended and additional flexibility has been introduced but nonetheless they are still very much present.

In this regard, the cap of $1M means that you are not allowed to raise more than $1M from an equity crowdfunding platform in a period of time of 12 months. The average seed round in the US is about $2M so this means that early-stage companies are very much setting themselves up for failure as they are going to be underfunded.

The costs are a big challenge in terms of the pros and cons of crowdfunding and more especially equity crowdfunding. Right away people will need to fork over $50K for audits and reporting without even knowing if they are going to be able to raise any financing.

Unfortunately due to the nature of the rules and how far away they are from the reality that startups and investors face, the hyper-growth startups that gain traction avoid this route and end up going with the traditional sources of capital (e.g. VCs, private equity, etc). Ultimately this creates adverse selection which means that only those that were rejected by the traditional sources end up launching themselves on an equity crowdfunding platform as the last resource.

Furthermore, the SEC did not allow special purpose vehicles (SPVs) for this kind of fundraising. This means there was no real way to group investors into a single entity with a managing member that would represent all the investors and the only source the entrepreneur would need for a signature.

This creates a mess on the cap table as now the entrepreneur is stuck doing investor relations with small ticket investors and needing to chase for signatures whenever there is a subsequence round of financing or acquisition in order to get the needed approval.

Moreover, you may find interesting the video below where I cover in detail how crowdfunding works for entrepreneurs.

Besides these hurdles, which apply to equity crowdfunding, overall entrepreneurs need to keep very much in mind the cons that apply to any form of crowdfunding from below.

1) Picking The Best Crowdfunding Platforms

There are probably hundreds of crowdfunding platforms out there today. A number of them have gone bankrupt in the past few years, but there are still lots of them.

This creates the extra step of having to pause and evaluate them. Which ones are good? Which are the best fit for your specific startup and product? Which will allow your type of business and raise? Which are still financially stable enough to pass through your money once the round is complete?

2) Costs Of Marketing & Promoting

Probably the most significant and damaging when considering the pros and cons of crowdfunding is that first-time entrepreneurs don’t have realistic expectations. 

You can’t expect to just throw up a page, and bring in millions tomorrow.

At least half of all crowdfunding campaigns fail. Probably a lot more than that. Those which are the most successful invest insignificant marketing, promotion and PR for their campaigns. They have to start early and get commitments before launching, and then keep up that moment for weeks or months. 

It is typically recommended to be ready to invest as much as 25% of the money you hope to raise, just to market it. This can all be on top of your initial pitch deck and campaign collateral creation costs.

3) Filtering The Best Investors For Your Company

This is probably one of the most obvious factors behind the pros and cons of crowdfunding. Experienced founders will tell you that who you bring in as investors are extremely important. It will matter for daily business, trying to raise future funding rounds and agreeing on an exit. 

When you are crowdfunding on these platforms you may have very little ability to filter these investors. You may have no right to accept or deny them. You get their money. But you may not really know who you are letting into your company and how well they will play with the rest of the team over the lifetime of your company.

4) Public Failure

If your campaign completely flops it can be up there on the internet forever. It will be on Google when people search for you and your company. This may not be very desirable. 

If you got close to your goal that isn’t too bad. And if you do make it over 50% funded, you can usually extend and pick up the momentum to finish the round.

Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

Hope this post provided some light behind the pros and cons of crowdfunding. Feel free to leave a comment below with what has been your experience using this source to finance your business.

FULL TRANSCRIPTION OF THE VIDEO:

Hello, everyone. This is Alejandro Cremades, and today we’re going to be talking about how crowdfunding works for entrepreneurs. In the last few years, crowdfunding has exploded as a great way for entrepreneurs to raise money. In today’s video, we’re going to dive into it, and we’re going to break it down for you so that you really get it and that you understand what crowdfunding can do for you. So, with that being said, let’s get into it!

What is crowdfunding? Crowdfunding essentially is when you have a pool of individuals coming in to contribute collectively a certain amount of money. That could either be done in exchange of a product or in exchange of shares in a company where they are putting the money in. Essentially, they are all coming as a group, and they’re going to be expecting something in return for that money that they are giving you.

In terms of what’s new around crowdfunding. Crowdfunding has been developed with the booming of the internet. Before, it was very hard to get a collective group of individuals at this level of volume or speed, and now, the internet has allowed for these types of programs, initiatives, or projects to launch themselves, put up their story, and get those donations or get those investments from a big pool of individuals.

Before, it was not a CC. Now, it’s as simple as having a great initiative, having a great project, having something that is inspiring people, or having something that you’re pre-selling that is getting people excited enough to open up their wallet and give you the money.

Also, what has happened in the past couple of years has been new regulatory frameworks that the government has approved in order to allow everyone, as well, to invest in companies online. This happened with the Jobs Act that was signed into law by Obama in 2012. This allows not just the accredited investors, which are the people that are collectively making collectively with their spouse more than $300,000 a year, but also for the average person to be able to invest in these types of companies.

We’re going to have different types of crowdfunding platforms. The first one is the donation-based crowdfunding. That’s a collective group of people giving money and not expecting anything in exchange. That also happens when you’re getting a t-shirt or selling a story that is compelling, that is inspiring people. You’ve seen great platforms here like Kickstarter or IndieGoGo, where people are also pre-selling their product, where you are buying something that you couldn’t buy anywhere else. It’s also a great way, also, to create a following to get exposure and to get some press mentions because of the great momentum and the traction that you’re picking up from the market.

Then the other one that you’re going to have is the equity or the debt, which is where you’re getting investors in, and you’re giving them a piece of the equity in the business. In this case, you’re going to have great platforms like StartEngine! Or you’re going to have SeedInvest where you’re putting up your project, you’re putting up your offering with the offering documents, and people are coming in, they’re giving the money, and then you are giving them shares in the business.

You’ve got to be very careful here because there are different laws that apply. There are different rules that come into place when you are raising money from investors online, especially if we’re looking at nonaccredited investors, and you need to make sure that you’re applying by the rules.

Obviously, there are certain limitations around the amount of money that you can raise around the type of reporting that you need to do around the vehicles that you can use in order to group those investors. So, you want to make sure that you’re consulting with your corporate lawyer to give you the right guidance.

Why crowdfund your startup? If you’re selling something tangible, I think crowdfunding is a great way to start getting those sales in. It’s also a great way to get PR, to get exposure, and to get the word out. I think, for example, if you’re more a technology startup or something that is not as tangible, maybe offering a beta test or giving a t-shirt in exchange is not going to be as compelling, so I think at that point, you may want to take a look more at the equity or debt-based type of crowdfunding. But if you’re around donations, and you have something tangible, it’s a great way to get those sales in. 

Again, I think it’s a great way, too, to seek validation. In many instances, before you even go out and raise a larger round of financing, you can use this toward investors to show them that the market has reacted very well, that they verified the fact that there’s a need for what you’re creating, and in many instances, the investors love this.

In terms of where crowdfunding belongs in your plan, this should be used in the very early stages. That’s either you are ready to go for friends and family, or you’re ready to go for a seed round of financing, but it needs to happen in the early stages. 

You could be a bigger company, for example, and you want to seek validation on certain lines of products that you’re launching, but typically, crowdfunding is used and works very well when the company is in the very early stages. Maybe it could be in the first year or the first couple of years, but you are getting things in motion. You’re getting up and running.

Choosing the right crowdfunding platform for your business or for your initiative is critical. You want to do some research. You want to know the types of projects they are launching there, maybe it’s more healthcare, or more media, or more hardware, or more towards films, or movies, or whatever that is. But you want to know that you’re launching your project in a platform where you are going to be able to find your community because the thing about crowdfunding is that first, everything is going to happen from your own first-degree and second-degree of connections. 

Once it’s picking up some momentum, you’re getting that layer of social to form so that the third-degree of connections, meaning those people inside of that community are going to jump in also. That’s why you want to make sure you go to a platform where you’re going to be seeking or seeing some of those people who are going to be more inclined to invest or contribute to your project. You want to first make sure that’s the right type of audience.

The next thing is, you want to understand whether there is enough of a community in there that it justifies the time you’re going to be allocating. Here, you can use websites like SimilarWeb or Alexa to understand what kind of traffic of users those platforms are generating because you want to be in a place where there are going to be a ton of eyes rather than in a place where you’re going to be launching your project, and then all of a sudden, it’s going to be crickets.

In terms of crowdfunding versus other startup fundraising channels, my take is that if you’re going after the donation-based crowdfunding, I think it’s great to validate and verify what you’re doing, but I think you’ve got to be very careful if you’re going out for investments because right now, the community of investors are seeing specifically the sophisticated like venture capital firms and angel investors. They see you launching on a crowdfunding platform as perhaps an adverse selection, and that means that everyone else rejected you, and for that reason, you’re launching yourself on that platform. 

So, you need to make sure that you’re addressing that, that you’re not launching yourself because this is the last resource, and that you would be able to explain that later on to other investors. Essentially, it’s something to be very careful about because the way you raise money today is going to impact the way that you can raise money tomorrow.

With that being said, I’d love to hear on the comment section below what you think about crowdfunding and how you think it could help you. Then, also, take a look at liking this video and subscribing to the channel so that you don’t miss out on all the videos that we’re rolling out every single week.

Then, take a look at the fundraising training, which is the program where we help entrepreneurs from A to Z with everything related to fundraising. There you’ll find live Q&As, templates, agreements, a community of founders helping each other all over the world, and I think that you’ll find tremendous value in it. Thank you so much for watching.

 

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Neil Patel

I hope you enjoy reading this blog post.

If you want me to help you with your fundraising, just book a call.

Book a Call