Question: I have been trying for the last six months, without success, to acquire funding to complete development and marketing of my idea for a new roofing product. Several people have suggested crowdfunding as an alternative, but I’m clueless as to how that works. Can you provide a crash course?
Answer: For startup entrepreneurs experiencing difficulty — or exasperation — in trying to get financing for their businesses via traditional means, crowdfunding offers an alternative.
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 (which you will most likely need to personally guaranty), 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.
It’s a collective online effort that can expand your professional network and introduce your business to potential customers.
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)
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. This article focuses primarily on rewards-based crowdfunding.
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,” says 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. Whereas with equity crowdfunding, you are giving up equity and 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. You should not automatically default to Kickstarter or Indiegogo, as there may be better options. Remember, 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,” says 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,” Dargie says.
• 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 advisers before embarking on a crowdfunding campaign.