Crowdfunding is a revolution that is changing how we all think about financing. This industry has been doubling almost every year, becoming a multi-billion dollar institution that has helped entrepreneurs from every walk of life introduce new ideas to the marketplace. The advantage of crowdfunding is that cash raised becomes instant capital that doesn’t need to be returned, unless a business does equity crowdfunding. The disadvantage is that there is no guarantee that an idea is going to be successful.
You might think you’ve got a great idea, but the marketplace might disagree with you and choose not to fund your campaign. Before you get involved with this process, it is important to evaluate these key points. Here are the pros and cons of crowdfunding.
The Pros of Crowdfunding
1. Anyone can reach out to a global audience to find success.
Anyone who has access to the internet and a bank account or credit card can participate in crowdfunding. Although equity crowdfunding is generally restricted to a certain jurisdiction or nation, rewards-based crowdfunding is open to virtually everyone. This allows a business to reach out to a global audience in an effective way even if they’ve never sold a single item or service before. Size doesn’t matter. You can be an organization of one, working from a home computer in a studio apartment, and still receive funding levels in the millions with the right idea.
2. It is an effective way to test the value of an idea.
In the traditional marketplace, it could be several years before the true worth of an idea can be discovered. This takes a major investment to accomplish without a guarantee for a return. In contrast, crowdfunding can help to prove the validity of an idea in 90-120 days with a highly organized campaign. Most campaigns can be launched for a minimal capital investment as well, even if professionally produced videos and extensive marketing of the campaign occurs. In other words, it doesn’t cost a lot to potentially get a huge return.
3. It provides an easy way for customers to interact with a brand.
Investors who are interested in an idea can directly interact with a brand through most crowdfunding platforms. They are able to ask questions, take a look at a company’s financial disclosures, or look at their history of success [or failure] in previous crowdfunding campaigns. When those behind a campaign then answer questions, provide needed data, and provide consistent updates about the idea being marketed, then a brand loyalty is developed that will extend beyond the crowdfunding campaign. This happens even if the campaign isn’t successful.
4. It eliminates the gender stigma that exists in the business world.
When men and women give the exact same sales pitch in person, most people prefer the male pitch to the female pitch. If that sales pitch happens through a crowdfunding campaign instead of an in-person presentation, the dynamic is the opposite. Women successfully close crowdfunding campaigns more often than men, raise more money per campaign than men, and draw in more investors per campaign. Crowdfunding in the future could potentially be the force that eliminates the glass ceiling for good.
5. Except for equity crowdfunding, there are no limits to what can be raised.
Pebble has raised over $30 million in just two successful crowdfunding campaigns. The Coolest Cooler raised over $13 million. Even Reading Rainbow raised over $5 million and received another $1 million from an angel investor. Unless you’re raising equity capital, the sky is the limit for your funding and it is only a matter of time until we see a $100 million campaign come along. This is why a focus on innovation right now could be incredibly profitable in the future.
6. Success often leads to more success.
Investors like to support winners in the crowdfunding world. You’ll find that many investors will come along after you’ve met your funding goals because they want to get some skin in the game. This success can lead to new crowdfunding opportunities later on because you’ve already got a core set of supporters who are actively involved with your brand. You’ll still have the same amount of work to complete on every new campaign, but the one thing you won’t have to do is start a group of brand ambassadors from scratch.
7. Business can fund limited run products for those who are interested in them without high capital expenditures.
Let’s say you have a great idea for a t-shirt. Instead of creating prototypes, testing them, giving some to the targeted demographic for free, and then spending a fortune to market it, crowdfunding lets you get cash up front to create the product for those who want it.
The Cons of Crowdfunding
1. You can be doing a lot of work for nothing.
Many platforms require entrepreneurs to meet their stated goals in order to receive the funds that have been pledged to their idea. This means you could potentially put in 6 months of work and receive absolutely nothing for it except the experience of running a crowdfunding campaign. Some platforms allow entrepreneurs to receive any funds that are received, but for a rewards-based campaign, that can also be problematic because orders have to be fulfilled even though a budgetary need hasn’t been met.
2. You’re going to be paying fees on the cash that you raised.
Crowdfunding platforms take a commission for your ability to raise funds. There are also credit card processing fees that are taken out of the pledges that are contributed to a crowdfunding campaign. On some platforms, this combination of fees can exceed 10%. That doesn’t seem to bad until you realize that if your campaign raises $13 million like Coolest Cooler did, you’ll be paying $130,000 of that in fees before you ever receive any cash.
3. There can be immense tax implications.
Many entrepreneurs don’t realize that the money raised in a crowdfunding campaign is considered income. If the company is structured as a sole proprietorship or a general partnership, this surge of money can count as income. It is possible to lose 20% or more of that money raised to the federal government in the United States, another percentage to state taxes, and there may even be local taxes to pay as well. Before raising any money, it is important to know what your tax consequences will be, even if your business is incorporated, so you don’t face an unpleasant surprise later on.
4. It takes a lot of work to pull off a successful campaign.
There are always exceptions to this rule. Some ideas just go viral on their own and no work has to be put into the campaign at all. For the average entrepreneur, however, a new crowdfunding campaign will typically create a new full-time job for the next 6 months. Even if that work is spread out over a team of people, you’re adding hours to the working week.
5. It is very easy for other entrepreneurs to copy your ideas if you haven’t protected them.
If you haven’t protected your proprietary information before you start a crowdfunding campaign, then there’s a good chance someone will try to scrape your idea. It is easy enough to take your videos, your campaign materials, and other data and start a new campaign on a different crowdfunding site under their name. This splits the cash that can be raised and it can be difficult to detect these scraped campaigns unless vigilant monitoring takes place.
6. A true valuation can sometimes be difficult to achieve.
The valuation that traditional investors might place on a new business can be very different from what the market itself may provide for a valuation. The crowdfunding marketplace tends to provide valuations on potential, while traditional investors look at tangible assets and sales. Thea difference between these two valuations can be tens of millions of dollars. If you need a true valuation for your business, funding the balance between these two figures can be difficult to achieve.
7. There can be a lack of accountability.
Even when considering equity crowdfunding, there is an overall lack of accountability in this marketplace that allows entrepreneurs to act without direction from those who have made an investment. Kickstarter often tells investors that it isn’t a store. Equity investors may be involved at such a low level that they have no way to be able to influence the direction a company takes. Due diligence can stop some of this, but once an investor gets a bad taste in their mouth, it can make it difficult for them to support your campaign even if it is on the up and up.
The pros and cons of crowdfunding balance your creativity and marketing efforts with the attractiveness of getting involved with something fun and exciting. By weighing these key points, you’ll be able to know if a crowdfunding campaign is something to consider for the next idea you’d like to bring to the market.