The beginner’s guide to crowdfunding - by Sifted
The beginner’s guide to crowdfunding
Crowdfunding has become a go-to form of fundraising for companies — big and small. Here's what you need to know before you embark on your crowdfunding journey.
Crowdfunding has become ubiquitous, the go-to form of fundraising for companies big and small. All of us use products that successfully raised money via crowdfunding every day and allow ourselves the occasional chuckle at some of the, ahem, less successful campaigns. But, beyond the headlines, there are nuances to be aware of before embarking on your own crowdfunding project.
What is crowdfunding?
At the risk of stating the obvious, crowdfunding means receiving investments from a large number of individuals (or occasionally groups) to fund a startup or project. In comparison to more traditional funding methods, where the funding comes from a single institution such as a bank or a small number of investors, crowdfunding relies on numbers.
Campaigns are most often conducted via one of the popular crowdfunding platforms and investors typically have no face-to-face contact with a startup founder (or founders) prior to agreeing to fund them.
Rock ’n’ roll origins
Internet-based crowdfunding can actually be traced back to 1997, when the British rock band Marillion funded their American reunion tour via online donations from fans.
The success of Marillion’s campaign led to similar efforts from a variety of musicians and as a result ArtistShare — which provided artists with a dedicated platform to raise money from supporters — became the first crowdfunding website in 2001.
How does crowdfunding work?
In 2019 crowdfunding is no longer the sole preserve of artists and has become an immensely popular way for companies to raise funds.
While some companies like Scottish craft brewery BrewDog run their crowdfunding themselves, not all startups will have BrewDog’s reach when they seek initial funding and as such most will look to use an established platform to host their campaigns instead.
Popular sites such as Kickstarter, Indiegogo and a plethora of region-specific alternatives, provide startups of all shapes and sizes with a range of options for funding their projects.
What each has in common is the premise that a business uploads a compelling pitch to the platform in order to sell the potential of a company or its product, in the hope that users of the platform will invest.
The different types of crowdfunding
There are four major forms of crowdfunding and most major platforms specialise in a single type, so it is important to know which is most appropriate for the aims of your startup before you begin.
Equity (or investment-based) crowdfunding
Equity (or investment-based) crowdfunding is the closest form of crowdfunding to more traditional fundraising: you give away a set stake in your unlisted business in exchange for investment from a large number of backers. In much the same way as non-crowdfunding equity investing, the value of each investor’s stake increases or decreases depending on the success of the startup.
Equity crowdfunding does not involve pre-selling a product; instead you give up a part of your business.
Mike’s Fancy Cheese is an example of a successful equity crowdfunding campaign. Michael Thomson’s artisan cheese startup and his Seedrs campaign raised £80,000 from 98 UK investors in early 2013. In a Seedrs case study, Mike explained that he had opted not to try rewards-based crowdfunding as it would probably have meant giving away the first batches of his cheese, which would then prevent him from growing his business. In addition, Mike was “excited” by the possibility of having outside experience and expertise to help him, so for him equity-based crowdfunding was the perfect solution.
Popular platforms:
Donation crowdfunding
Donation crowdfunding only really applies to non-profits and small businesses with a local community focus. You effectively ask for donations to help launch your idea and so give away neither equity nor rewards in return for investment.
However, unless your idea relates to a charitable or local cause you are advised to consider other forms of crowdfunding, as people will rarely give something for nothing.
Led By Donkeys is an example of a donation crowdfunding campaign, where four friends set out to raise money to highlight public figures’ inconsistent statements relating to the EU referendum and Brexit in the UK. Another example is Oldham Food Bank Community Kitchen, an organisation that raised nearly £24,000 to allow them to build a community kitchen in Oldham Food Bank.
Popular platforms:
Debt (or loan-based) crowdfunding
Debt (or loan-based) crowdfunding is sometimes referred to as peer-to-peer (P2P) lending. Investors lend your startup money that you have to pay back at an agreed point in time at an agreed interest rate. Think of it as a bank loan without a bank.
The predictability of set monthly repayments can be appealing to more established firms, though the majority of startups use other forms of crowdfunding as most peer-to-peer platforms require businesses to have been launched at least 12 months before funding is sought.
Debt-based crowdfunding can be useful if you have been unable to raise the finances you need from banks. The terms of the loan, including its APR (annual percentage rate), will be decided upon by the crowdfunding platform. If you are seeking a significant amount of investment you may be required to provide security in the form of a personal guarantee or business assets.
Although few startups have access to debt-based crowdfunding, it can be an excellent way for small businesses to grow quickly. And the industry doesn’t matter either; everyone from mini golf courses to firms offering computer management solutions for flooring companies have been able to raise funds via peer-to-peer lending.
Popular platforms:
Rewards-based crowdfunding
Rewards-based crowdfunding is the type of crowdfunding that most of us are most familiar with.
The investors are offered pre-release products or services, usually available at ‘early bird’ prices or with additional enticements, in return for set donation amounts. There is even a recent trend for large companies crowdfunding experimental products — like Gillette with its heated razor — partly as a way of gauging appeal and raising awareness of the product.
Some of the most popular rewards-based crowdfunding platforms (including Kickstarter) operate on an all-or-nothing basis, in that if you do not reach 100% of your funding campaign goal the campaign is deemed to have failed and you will not receive any of the funds that your backers have pledged.
Successful rewards-based crowdfunding campaigns include the likes of Oculus (who funded the Oculus Rift virtual reality headset and was late acquired by Facebook) and Pebble, who both created multi-million dollar companies following crowdfunding campaigns.
But even if you set your sights lower for your startup, rewards-based crowdfunding can be an effective way to build awareness and funds. A cursory look at the projects currently close to success show myriad different types of startup, from boutique surfing magazines to sci-fi video games and post-surgery lingerie. And don’t think that your product might be too niche to be successful; after all Rob Ward raised $28,000 (close to double the original goal) to back Opena, an iPhone case incorporating a slide-out bottle opener!
Popular platforms:
- Kickstarter
- Indiegogo
Why would you want to crowdfund?
The reasons to crowdfund your startup are plentiful.
Speed
The first is its potential speed in turning an idea into a functioning business. Traditional forms of investment involve pitching to multiple people and institutions, a potential drain on both time and resources. Crowdfunding platforms allow startups to reach a vast audience via a single online pitch. Crowdfunding is also a democratisation of the entire investment process, opening up opportunities for both startups and novice investors that simply aren’t accessible via other means.
Flexibility
Crowdfunding is arguably the most flexible form of startup fundraising. Not only are there several different types of crowdfunding, but with each you’re in control and you make the decisions, including how much you need to raise and what rewards you are able to offer.
Brand building and interest gauging
If you decide to use a rewards-based platform crowdfunding can be a hugely effective way of building brand loyalty at the same time as raising funds. By offering people the opportunity to invest in — and potentially receive — an exciting new product before anyone else, you benefit not just from the injection of capital but the potential to create evangelists for your startup. It allows you to build a community which is passionate about your ideas much earlier than other forms of investment. For an individual — who may well have little to no experience of investing — to show faith in your startup at an early stage makes it likely that their passion will translate to extolling its virtues to other potential customers.
A crowdfunding campaign can also help you gauge interest in your idea. After all, it is your own potential customers that are showing interest rather than professional investors.
A way to mitigate risk
Finally, if seeking donation or rewards-based investment, crowdfunding your startup could be seen as a way of mitigating risk for both you and the business. You will not be in debt and you will retain complete control.
What do you need to do before you crowdfund?
The biggest mistake you could make would be to think that crowdfunding is easy. The most recent statistics show that only 37% of projects on Kickstarter met their campaign target. Of course, this means that nearly two-thirds of projects did not suceed.
To maximise your chances of success preparation is key.
The first thing to do is to produce a detailed, comprehensive business plan that allows you to pinpoint precisely what your startup needs and when it needs it by. The better the business plan, the more confident you can be that you will be able to meet the promises you make in your campaign. You should also be aware that, although many crowdfunding platforms do charge a fee from you when you launch a campaign, they are likely to take a percentage of the final amount you receive as a payment. You should therefore factor this into your figures.
Once you have a business plan which you have full confidence in, you should decide which type of crowdfunding fits best with your startups needs, aims and ethos, before deciding which platform to use.
But the preparation is only just beginning. You may not be doing it face-to-face, but crowdfunding still involves you pitching your idea into a crowded (pun half-intended) marketplace.
So how do make your campaign stand out?
Running a cohesive and eye-catching crowdfunding campaign takes planning.
Early momentum is crucial to a campaign’s success. To achieve this you need to maximise your startup’s visibility prior to launching your funding drive by engaging with as many relevant people as possible so that the launch of your campaign is not the first they have heard of you or your product.
Friends and family are also valuable resources. If you can convince them to back your campaign en masse (as well as singing your startup’s praises to others!) in its early days your pitch looks popular and hence more viable to others.
A pitch also requires transparency. You should ensure that your campaign provides as much information as possible to potential investors and customers about you and your brand, values and goals.
This may seem counter-intuitive, but this is particularly true when launching a rewards-based campaign. Yes, your investors are likely to be parting with a relatively small amount of their money when compared with, say, an angel investor. But they may well also have significantly less money and buying a product that does not yet exist requires a major leap of faith for an individual.
So, make as compelling a case as possible for why they should take that leap. Videos showcasing not only your product’s strengths but those of your team can be effective. So too can communicating with your backers — a personal touch at an early stage, whether it is regular updates on your progress or thanking each person for their investment, can go a long way in building trust with your growing community.
These tips won’t guarantee that your startup is part of the 37% that meets its funding goal, but they will certainly help!
Crowdfunding: what could possibly go wrong?
Clearly crowdfunding is an enticing prospect, but it is not without risk.
As mentioned earlier, nearly two-thirds of projects on Kickstarter fail to meet their target. This is clearly bad for a startup in the short-term, but the long-term damage to your firm’s reputation could be even more serious.
Failed campaigns remain visible on most crowdfunding platforms and, just as early positive momentum can have longer-term benefits, a negative early perception can do lasting damage. If you have failed to secure crowdfunding this could have a detrimental impact on future attempts to raise investment as future investors may see historical failure to do so as a sign that it’s not a venture worth investing in.
Crowdfunding can also prove tricky if you find that you are not able to meet your initial promises and rewards. Not only can it be complicated from a financial or legal point of view, you risk turning believers into doubters at a crucial stage of your startup’s trajectory.
Finally, with rewards-based crowdfunding you will have to accept the double-edged sword of having little to no outside input. As with bootstrapping, this lack of outside ‘interference’ can of course provide many people with the motivation to fund their startup via a crowdfunding campaign. But others may value the expertise provided by the likes of angel investors or venture capitalists.
Conclusion
In spite of its potential risks, it is easy to see why crowdfunding has become such a popular way for startups to finance their nascent stages. If used correctly it can be accessible, quick and flexible, as well as providing an invaluable way for firms to make early connections with customers and build trusted brands.
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