Securing startup capital can be one of the most significant challenges a new entrepreneur faces. Regardless of how clever or innovative a business idea is, there may be very little to attract investors or lenders, particularly, if a new business lacks proof of market viability, collateral assets, or mind-share.
Of course, entrepreneurs are nothing if not resourceful, and many startups have begun to use crowdfunding platforms and tools (like IgnitionDeck) to raise capital, build customer awareness, and better understand their corner of the market. These are three of the ways we’ve seen how crowdfunding offers special benefits to new businesses, compared to more traditional (and potentially more risky) funding models.
Crowdfunding can put money in a business’ bank account without adding to that business’ debt load.
“In simple terms, crowdfunding is the financing of a project or a venture by a group of individuals instead of professional parties (like, for instance, banks, venture capitalists or business angels),” wrote Armin Schwienbacher, a finance professor from the SKEMA Business School at the Université Lille Nord de France, and Benjamin Larralde, the founder of Hackster.io, in a paper about crowdfunding published in 2010.
“In theory, individuals already finance investments indirectly through their savings, since
banks act as intermediary between those who have and those who need money. In contrast,
crowdfunding occurs without any intermediary: entrepreneurs ‘tap the crowd’ by raising the money directly from individuals.”
Tapping the crowd can take a couple of forms.
First, non-equity crowdfunding, wherein backers essentially donate capital in exchange for an intrinsic reward or limited edition product. These backers pay more than market value for the reward and, thereby, provide debt-free capital for the business.
In most cases, the capital is delivered almost immediately, while the reward for backing can be delivered much later.
Equity crowdfunding is a second and emerging option. With equity crowdfunding, investors receive company shares in exchange for their cash investments. Here again the business gets fast access to capital without incurring debt.
In April of 2012, President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. The JOBS Act, in title II and particularly title III, allows for equity crowdfunding, but the U.S. Securities and Exchange Commission (SEC) has not yet completed all the necessary rules (noteably, those concerning non-wealthy and unaccredited investors). As it stands, the JOBS Act does mean that companies can have more shareholders before being required to register with the SEC. And at IgnitionDeck, we are optimistic that legislators will continue to see the value in new ways for buisnesses to get off the ground with minimal risk.
Crowdfunding a new business can help that business earn a following that will ultimately contribute to its success.
It may seem like the primary benefit of having fans excited enough about a business to back it is, well, the money, but consider that this cadre of followers is just the sort of group marketers at large companies dream about nightly.
As an example, in 2012, Adobe released a report titled, “The ROI from Marketing to Existing Online Customers,” which argued that loyal customers where valuable in two ways. First, repeat customers are worth more over time, since they make repeat purchases. Second, repeat customers also tend to spend more on each purchase. In fact, Adobe found that a repeat customer, who had made three or more purchases, spent five times more than a new customer on each individual transaction.
A successfully crowdfunded business has already created a loyal fan base, often willing to make repeated purchases over time (and spend more on each puchase than a one-time customer). These super-enthusiastic customers are all the more likely to spread the word about new and exciting products and services.
There are few tools that can tell an entrepreneur more about how a new product or service will be received in the marketplace than crowdfunding.
When a business sets up a crowdfunding offer it’s not just creating a financing vehicle. It’s also establishing a test market, wherein potential customers can vote with dollars for (or against) a product’s ultimate viability.
As an example, consider the case of Canary, a home security device that retails for about $250.00. The company had some offers from more traditional funding sources, but did not believe that those investors had placed a proper value on the product or the company.
So Canary set up a crowdfunding offer in July 2013 hoping to raise $100,000. By the time the campaign ended on August 26, 2013, Canary had raised more than $1.9 million. The massive support Canary received via their crowdfunding campaign served to demonstrate that Canary was not only a viable product, but was also very obviously in high demand. As a result of the success of the crowdfunding campaign, traditional investors were then willing to give Canary just about anything it wanted, because the market had validated Canary’s product.
Similarly, crowdfunding can also inform entrepreneurs when something won’t work. If a new product or service gets very little crowdfunding support, it may indicate that the product is not market-ready (or that the market is not ready for it). But even in this case, the low-risk factor that crowdfunding can provide makes it a very appealing choice of fundraising.
Crowdfunding offers the above advantages over traditional funding models, but launching a crowdfunding campaign is obviously no guaruntee of immediate success. Crowdfunding sometimes requires a steep time investment that may or may not result in a huge payout. But remember, short-term failure does not indicate an end. It may simply mean that your plan of attack might need to be retooled. And crowdfunding is a relatively inexpensive and risk-free way to figure out your market sector and stay in touch with your project’s true believers.