What is Crowdfunding?
Crowdfunding, most simply defined, is an alternative source of funding for SMEs (small to medium enterprises) and local community projects. Instead of securing funding through traditional methods, such as bank loans, it allows SMEs to secure funding through private individuals (“the crowd”). This means that companies that would otherwise be unable to secure funding now can. Crowdfunding has become a powerful financing tool that is significantly altering the entrepreneurial ecosystem.
Types of Crowdfunding
Crowdfunding primarily occurs in three forms: donation, debt, and equity.
Donation crowdfunding targets customers that believe in the company’s cause; either charitable or innovative. However, unlike other forms of crowdfunding, investors do not typically benefit financially from the success of these campaigns. Services such as CrowdFunder, Kickstarter, Indiegogo, and RocketHub provide donation-based platforms for SMEs to typically obtain funds to launch a new product while services such as GoFundMe, YouCaring.com, GiveForward, and FirstGiving provide donation-based platforms for charitable causes. These platforms normally take a 5-10% commission fee.
With debt crowdfunding (also known as crowd lending or peer-to-peer lending), companies request loans from investors and these loans are paid back with interest. It essentially allows SMEs to borrow money without applying for a traditional bank loan. These loans are often have more competitive and lower interest rates and greater flexibility and options for obtaining resources than conventional funding sources. As a result, debt-crowdfunding is particularly attractive for startups and small businesses. It is also beneficial for investors as they not only receive their money back with interest, but often receive dividends on company shares. Platforms, such as Upstart, Prosper, and FundingCircle, can help SMEs secure peer-to-peer lending.
Equity crowdfunding allows the general public to invest in an early-stage unlisted companies in return for company shares. Essentially, investors have partial ownership in the company and, thus, profit when and if the company succeeds. Investors should be aware that equity crowdfunding does include certain risks as they could lose their investment when and if the company fails. This method is most beneficial for startup businesses that need a small amount of investors to become established. Common platforms for equity-crowdfunding include WeFunder, Localstake, AngelList, and EquityNet.
Benefits of crowdfunding
Crowdfunding, regardless of form, can provide numerous benefits for companies that would otherwise be unable to quickly secure funding. The average campaign lasts for approximately nine weeks and over that period a successful campaign raises on average $7,000. Typically, crowdfunding platforms do not charge an up-front fee and can help companies access capital while saving time and money. Unlike obtaining funding through banks and credit unions, companies do not need to go through the process of constant pitching, prospecting, and negotiating. Instead, companies create online profiles that promote their cause and help them to connect with investors. As investors typically benefit from the success of the company, they not only become loyal customers, but also help to promote the company through word-of-mouth and, thus, are essentially an extension of the company’s sales force. Customers’ reactions to business ideas and their willingness to invest also provides valuable insight about the company’s marketing strategy and potential prosperity.
Drawbacks of crowdfunding
However, crowdfunding, of course, is not appropriate for all companies. As individuals invest in companies that they identify with, companies that are aimed at businesses are not likely to succeed on crowdfunding. Complicated and complex projects are also unlikely to succeed as the average person may not comprehend or be attracted to the product. Additionally, crowdfunding is most commonly appropriate for projects seeking less than $100,000. Projects that require more than $100,000 would probably benefit more from conventional funding methods. Another disadvantage of crowdfunding is that most platforms use an all-or-nothing approach, which means that if the project fails to achieve its funding objective then funds will be returned to investors. Once funding has been received, companies cannot drastically alter their business approach or suffer significant delays without damaging their reputation and brand.
Some companies have had incredible success on crowdfunding. One of the most successful crowdfunding campaigns was led by Pebble Time— a smart watch company. This campaign raised $1 million in less than an hour to become the quickest funded campaign in history. In total, it exceeded its original goal of $500,000 by 4,067% to raise $20,338,986. Another extremely successful campaign was run by Coolest Cooler, an innovative cooler company, which raised $13,285,226 (26,570% of original objective) to become the most funded Kickstarter campaign in history. Successful campaigns have covered a range of categories including design, technology, games, film and videos, and even education platforms. More information about some of the most successful crowdfunding campaigns can be found here.
Creating a successful campaign
However, the vast majority of campaigns are not successful as The Crowdfunding Centre released a report that stated that in 2015 69-89% of campaigns (depending on the platform) did not reach their funding goals. Despite having the highest success rate, on Kickstart, in 2015, only 31% of campaigns were successful. Creating an effective campaign is clearly challenging, but advice for hopeful SMEs is plentiful. One of the most useful sources for planning a successful campaign is Kickstarter’s Creator Handbook.
The importance of Storytelling
The Creator Handbook emphasizes storytelling as one of the most essential aspects of a successful campaign. As crowdfunding investors do not normally have a business background, the stats, figures, and product details that would normally work in conventional sales pitches are largely ineffective. Instead, emotive storytelling has a greater success rate. Research conducted by the Berkeley-Haas School of Business revealed that emotive language, such as the language most often employed by women, is more appealing to crowdfunding investors. Storytelling should clearly communicate the company’s background and mission and how it can relieve customer’s pain-points. The importance that investors play in helping the company to achieve its goals should not be ignored. Instead, investors should be incorporated into the story as agents that can create change and help the company accomplish its objectives. Additionally, videos and images should also be included as this can also help boost the company’s emotional connectivity and investors’ trust.
Other Methods for Success
Of course, storytelling is not the only aspect required for a successful campaign. It is also essential to establish a clear funding goal. Companies must consider how much money is required and if this goal is achievable? Remember that most platforms operate on an all-or-nothing system so establishing an unrealistic funding goal could be disastrous. Once a funding goal has been established, it’s important to properly promote the campaign. The average donation on Kickstart was only $91, which means that to be effective campaigns need to reach a large audience. Employing social media, digital channels including blogs, and hosting live events can all help to circulate the company’s crowdfunding message. It is important that investors take centre stage during a crowdfunding campaign and they should be regularly updated on any progress or set-backs. Most platforms have features for communicating with investors. Once the funding objective has been accomplished, any promised rewards or benefits should be fulfilled. Many companies, such as Pebble Time, run numerous crowdfunding campaigns and, thus, building a positive rapport with investors is essential for both the current and future campaigns.
Future of Crowdfunding
While launching a crowdfunding campaign certainly requires a lot of work, it can also be extremely beneficial. According to a recent report from World Bank, the crowdfunding industry is expected to be worth between $90 and $96 by 2025. In order to support this growth, industry professionals have predicted that the industry may see a growth in niche platforms targeted at specific groups, equity crowdfunding will become more common as regulations decrease the risks involved, investors will become more savvy, and new funding models may emerge. The quick and sustained growth of crowdfunding certainly suggests that this industry will only become more beneficial to startups and SMEs, provide even greater opportunities for securing funding, and may even significantly challenge traditional financial institutions and funding methods.