What Small Businesses Should Know About Crowdfunding

06 Apr 2016

Ann Logue

Ann Logue is a lecturer in finance at the University of Illinois at Chicago and a writer specializing in business and finance. She is the author of four books on investing in Wiley’s for Dummies series and has written for Barron’s, Entrepreneur, and Newsweek
Japan, among other publications. She lives in Chicago and holds the Chartered Financial Analyst
designation.

Crowdfunding is the most exciting area of business fundraising these days. Instead of presenting financials to bankers, companies bring their product ideas to potential customers and ask for commitments. Kickstarter, the largest crowdfunding platform, had 101,010 projects funded between the company’s founding on April 28, 2009 and February 29, 2016. The site represented 285,277 projects in total, for a success rate of 36.13 percent.

Different crowdfunding platforms have different policies. A company has to reach its goal on Kickstarter, or it receives nothing. Most of those who launched a project failed to raise any money at all. Much time and money has been invested by businesses on crowdfunding campaigns, with little or nothing to show for it.

Those that were successful on Kickstarter raised $1.9 billion, though. An investment of time and attention before, during and after the crowdfunding campaign can help improve not only its chances of success, but also enhance its role in growing the company.

Much time and money has been invested by businesses on crowdfunding campaigns, with little or nothing to show for it.

The first question to ask is what you want to accomplish, Aimee Cebulski, author of Kickstarter for Dummies (Wiley Publishing, 2013), said. A crowdfunding campaign can help a business raise money, sell products, build brand awareness and develop a database for future marketing efforts. It can also waste time and money while hurting goodwill.

“A crowdfunding campaign is a lot of work, and it is a lot of work every single day,” she said. “Are you comfortable asking for money? Because that’s what you’ll be doing.”

A crowdfunding campaign can help a business raise money, sell products, build brand awareness, and develop a database for future marketing efforts.

There are two types of crowdfunding. The first is raising money through the marketing of rewards, such as T-shirts or new products. With this, the money contributed is legally considered to be a gift of taxable income. This works great for companies that have brands and products of interest to consumers. Kickstarter is probably the best known of these crowdfunding platforms, but there are others such as IndieGoGo, GoFundMe and PledgeMusic.

The second form is raising equity. Instead of selling products or music downloads, the company sells shares in itself. It has long been legal for people with a high net worth to invest in small businesses. After May 16, 2016, the SEC will allow businesses to bring in up to $1 million a year in capital from regular people. This is allowed under Title III of the JOBS Act of 2012, so it often referred to as Title III equity crowdfunding. The SEC also expanded Rule 147, which provided for unregistered equity offerings, to all for online offerings of up to $2 million.

A rewards-based campaign works well for companies that have products to sell, Joy Schoffler, principal at Leverage PR, a public relations company that works with crowdfunding platforms, said. Businesses that aren’t consumer oriented may want to try something else.

“Maybe you’re a dry cleaner, and you’re looking for money to build a secondary location,” Schoffler said. Raising the money from the crowd can help you raise money and turn your customers into ambassadors for your business.

After choosing the type of campaign and the platform, Cebulski says that companies have to develop a plan for the campaign. Along with determining what rewards to offer and for what price, she said that crowdfunders need to find ways to attract backers.

“It is much harder to draw attention to your campaign than people think,” she said. Many successful crowdfunders work with consultants to help them create and promote their campaigns, but that raises the cost of the campaign, too.

Schoffler said that companies considering an equity crowdfunding campaign may want to try product rewards campaigns first, if they have appropriate items to offer. That way, a company can bring in some money while preparing for a more aggressive ask later – and test the waters without giving up equity or financial information.

With all that upfront work out of the way, the campaign itself will be a breeze, right? Wrong.

“It’s like having a full-time job,” Schoffler said. Instead of running the business, you’ll be running the campaign. Finding backers, directing them to the campaign site, answering their questions, and keeping them informed of the progress of the effort has to happen for the campaign to be successful.You can’t launch the campaign, go on vacation and come back to a pot of money.

The database of potential and participating backers is at the core of the campaign. Many of these people will be friends and relatives, which adds another wrinkle to the plan.

“Under-promise and over-deliver,” Schoffler said. “Don’t burn your entire support system.”

In fact, the period after the campaign closes is critical to the business, because it shows if you can deliver.

“There’s nothing worse than unhappy customers complaining on social media,” Cebulski said. “The campaign continues until all of your deliverables are out.”

If the campaign backers are now equity holders, then you have to make sure that you give them the information they want, Schoffler said. The investors will want to know what’s happening, but “there’s a real risk of them taking up a lot of your time,” she said.

Kickstarter reports that about 12 percent of Kickstarter creators have launched more than one project. That doesn’t count people who started on Kickstarter and then turned to other crowdfunding platforms to raise money or equity. The system is in place, and it works well for some businesses. Plan carefully if you want yours to join them.

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