What to know about crowdfunding

Though you won’t find much about it in older business books or articles, crowdfunding can be a uniquely modern and effective way to raise funds and take your business to the next level. Crowdfunding works by collecting small amounts of money from a large pool of investors to offset the costs of starting or growing a business. But before you press Publish on your crowdfunding page, you need to be aware of the different types of campaigns and platforms out there, to ensure this unconventional approach is right for you. 

Keep reading to learn more about crowdfunding, the different types of campaigns available and whether this is the right move for your company. 

What you’ll learn:

• Crowdfunding is a way to raise capital for your business by collecting funds from family, friends, community members and investors.

• There are different types of crowdfunding campaigns, each with its own set of pros and cons to consider.

• If crowdfunding isn’t the right option for your business, you could consider alternative financing options—like a business credit card—to support your company’s growth.

Crowdfunding, sometimes called crowdsourcing, is a way to raise money—typically online—by collecting funds from a large group of people, referred to as “backers” or “investors.” Businesses can use the capital raised from crowdfunding to support the costs associated with launching a new service or product. Some startups also use crowdfunding campaigns to help cover the initial costs of starting a business.

In general, there are four main types of crowdfunding campaigns, and the best option depends on the diverse needs of your business.

This crowdfunding model raises funds from backers in exchange for shares in your company. Startup companies tend to use this type because it has the potential to raise larger amounts of capital. Because equity-based crowdfunding gives backers a vested interest in the company, it can lead to long-term investor relationships and potentially open the door to their expertise and networks.

However, with this type of financing, you give up some ownership of your company by offering shares to backers. This can also mean backers share some level of control and decision-making power. And if you continue using equity-based crowdfunding as your business grows, you risk diluting ownership by bringing in multiple investors at different stages.

With rewards-based crowdfunding, you raise capital from backers and, in return, you provide a reward—typically in the form of a product or service offering from your business. Startups that are testing a new product or service might gravitate to this crowdfunding method to cover development and production costs. You could choose rewards-based crowdfunding if you want to keep your ownership stake in your company undiluted. It’s also a good option if you're testing a product or service, as backer feedback can provide valuable insights to refine your go-to-market strategy.

But this type of campaign is usually run on a crowdfunding platform, which typically charges a fee based on the amount of funds you raise. And depending on the platform, you might not receive any of the capital if you don’t hit your funding goal.

This type of campaign raises funds through donations from backers who, for the most part, contribute because they are interested in the cause. Since backers are not looking for compensation in the form of capital or rewards, donation-based crowdfunding is often used by startups or nonprofits because it aligns with larger community needs or social causes. Plus, donation-based crowdfunding doesn’t require repayment or giving up an ownership stake.

Because donation-based crowdfunding typically appeals to emotional or social causes, it can be more challenging to secure funding from a large group of backers. And depending on the platform, if you don’t meet your fundraising goal, you might not receive any of the funds. Some platforms also charge fees based on the total amount raised.

Debt-based crowdfunding, sometimes referred to as “peer-to-peer” (P2P) lending, works almost like a business loan. With this style of crowdfunding, you borrow funds to be paid back, plus interest, over a set amount of time. But instead of receiving the money from a bank, backers lend you the funds themselves. This allows you to maintain company ownership because your financial obligation to investors ends once the loan is repaid. And because the repayment schedule is usually fixed, it can be more predictable than other types of crowdfunding campaigns.

However, there are drawbacks to this crowdfunding approach. Debt-based crowdfunding can cost more than other campaigns because you typically owe interest to investors. Plus, if you miss payments, it could hurt your credit score. And if you used collateral to secure the loan and can’t repay it, your assets could be at risk.

If you think crowdfunding fits in your overall business plan, here are a few general steps you can take to get started.

Each of the main types of crowdfunding campaigns—equity-, rewards-, donation- and debt-based—comes with its own set of advantages and disadvantages. Review your business’s organizational structure and your capital-raising goals to determine which type of campaign would work best. Here are some things to consider as you make your decision:

• Can you give up any ownership stake? Equity-based financing can be the most effective approach to raise large amounts of capital. However, it requires you to give up some ownership in your company in exchange for funding—while other types of campaigns allow you to retain full ownership. If you’re looking to raise larger amounts of capital, leveraging ownership in your company might help you achieve this.

• What are the costs? Depending on the crowdfunding platform, you may have to pay a percentage of the funds you raise, plus other fees. And if you choose a debt-based crowdfunding campaign, you’re typically required to pay interest to investors. 

• How quickly do you need the funds? Certain crowdfunding campaigns—like equity-based campaigns—are more complex to set up and may require more time to secure the funds. And depending on the campaign type and platform you’re using, you might not receive any funds if you don’t hit a certain fundraising goal.

Once you’ve decided on the type of crowdfunding campaign that’s best for you, it’s time to determine your budget and set campaign goals. Consider the total funds you’ll need to raise to complete the project, and set goals based on these figures. Review fixed costs such as one-time fees, as well as variable costs that fluctuate based on production or sales. This will give you an accurate picture of the capital required.

While crowdfunding is typically accomplished through donations or raising funds from backers, there are still additional costs to note. For example, if you choose a crowdfunding campaign that charges fees or takes a percentage of the amount raised, be sure to factor these costs into your budget. You may also want to invest in marketing to reach a wider audience, so take these expenses into consideration before launching your campaign.

There are various crowdfunding platforms available, and the best type for you depends on the campaign you’re running. Here are a few things to keep in mind when you’re searching for a crowdfunding platform:

• Research the fee structure charged by the platform.

• Understand additional platform costs. 

• Consider your business’s industry and the audience the platform caters to.

• Determine if the platform requires you to hit 100% of your campaign in order to keep the funds you’ve raised.

If you think crowdfunding is a good option for securing funding for your company, here are some tips to help you run a successful campaign:

• Review successful campaigns that are similar to yours to learn from their strategies.

• Make sure you’re telling a compelling story to emotionally connect with prospective backers.

• Invest in promotional efforts, including high-quality video, photography and content marketing.

• Set realistic expectations for the amount of capital needed and the timeline for raising it.

• Communicate with backers regularly by providing updates and public mentions or offering insider benefits or rewards.

• Build a pipeline of potential investors by spreading the word about your campaign through social media or email blasts.

• Ensure you have the right resources in place to deliver on campaign promises.

There are some disadvantages of crowdfunding to keep in mind, such as:

• There can be hidden costs and fees associated with the campaign: Even though crowdfunding funds aren’t coming out of your pocket, there are often additional costs and fees to be aware of that can impact your overall campaign goals. 

• Raising enough capital isn’t guaranteed: Crowdfunding carries some risk, as you can't be certain how much capital you'll raise during the campaign. And if you choose an all-or-nothing platform, any funds raised will be redistributed to investors if the goal isn’t met. 

• It requires time and effort: Compared to other types of funding, crowdfunding can be a lengthier process for securing capital. Not only does it require ample planning and preparation to launch a successful campaign, but you’ll likely need to invest some time into ongoing promotional efforts. You’ll also need to consider the amount of work involved in following up with potential investors and backers.

• There can be apprehension from backers: Prospective backers may be hesitant to donate through a third-party platform as opposed to sending funds directly.

• Competition might be high: Crowdfunding has become an extremely popular source of fundraising, with countless new campaigns launching every day. Depending on your industry and the type of crowdfunding campaign, there might be market saturation, which could make securing funding more difficult.

For you as an entrepreneur, exploring different avenues for funding is an important step when expanding your business. If crowdfunding isn’t the right option for your organization, here are a few financing alternatives to consider:

• Business credit cards: Like a personal credit card, a business credit card is a revolving line of credit that can be borrowed from and paid back repeatedly. Compared to personal cards, business cards can be especially useful for company owners because they help separate personal and organizational expenses and tend to offer higher credit limits. Plus, they can offer business-specific benefits and rewards to support company needs. 

• Business lines of credit: A business line of credit works similarly to a business credit card in the sense that you can draw funds up to a certain limit and pay them back continuously. But a business line of credit usually has a draw period that ends after a set period of time. And business lines of credit rarely offer rewards programs or other benefits that business credit cards can provide.

• Business loans: You could try securing funding from a bank or credit union in the form of a business loan. This type of financing can work for small business owners who are comfortable paying back funds, plus interest, over a given period of time with a fixed payment. With business loans, lenders usually want to see an established business plan in place and an expense sheet to help with projections.

Crowdfunding can be a great way to secure funding from a large group of investors who align with your business goals and mission. But choosing this type of funding doesn’t guarantee you’ll secure financing, and it can require time and effort to run a campaign. If you’re interested in other company financing options—like a business credit card—you could consider business credit cards from Capital One and get pre-approved today, with no harm to your credit score.