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.
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.
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.
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.
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.
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.
ACCESS THE PITCH DECK TEMPLATE
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.