Five Reasons to Avoid Crowdfunding

In the wake of tight credit markets in North America, crowdfunding or crowdsourcing, has quickly become a source of readily available financing to startups, charities or projects. This form of financing is extremely popular with the creative industry such as documentaries, artists and writers.

This new form of financing allows a person to get funding through small contributions from a large group of individuals through an online platform.  The entrepreneur makes an online pitch to a community, which then decides if they want to support the project by giving money towards it.

Raising funds for your small business by crowdfunding has its own set of dangers that can be harmful to your company’s success.  Here are the top five reasons to avoid crowdfunding as a financing option.

Crowdfunding is not meant for large projects.

If you need a million plus dollars to get your business up and running, crowdfunding is probably not the best source for you. Yes, there have been exceptions, but raising the large pool of capital works best with venture capitalists that you can focus on as opposed to the sometimes-scattered approach of crowdfunding. The other thing to consider is repayment. Imagine trying to keep 1,000 investors happy!

Crowdfunding is not sophisticated investing.

There is a kind of hip, underground vibe to crowdfunding. You could kick in a couple of hundred dollars towards an edgy independent film and feel like you’re part of the creative process. However, some professionals might not want to open up their business plans for such wide scrutiny.   

Crowdfunding could impact future investments in your company.

If you're tapping into crowdfunding as source of capital, you want to think about the longevity of your business. A single project can benefit from the financing, but if you've giving up shares in a company that might become extremely successful, those shares could tangle up future investment opportunities. See "The Social Network" for a perfect example of this dynamic playing out with billions at stake!

Crowdfunding has a limit on share values.

The cap with crowdfunding is $1 million. If you manage to raise more than that amount you'll be frozen out of crowdfunding for at least a year unless you want to become involved in security registration compliance. Suppose your company experiences rapid growth? You might be stuck if crowdfunding is your only cash flow source.

Crowdfunding is not a quick option.

If you need cash fast, crowdfunding is not the way to go. Once you place your proposal up on a site you essentially have to wait until it catches "fire." You'll also have to do a lot of your own promotion to drive people to your plan. This process can stretch on for weeks and months. Now consider being approved for a loan from a bank and having the funds by the end of the week. Which works better for your plans? 

Is Crowdfunding the Best Strategy for Your Startup?

In the last few months, there has been a new trend in startup investing that has gotten the attention of the VC world.  Taken from the idea of crowdsourcing - crowdfunding allows the smaller investor to get into investing into a potential startup by mitigating the risk with a group of people.

As Blake Coler-Dark mentions, crowdfunding is.. “The ability of many individuals to fund a specific project or individual.”

This is what makes crowdfunding so appealing to many people - it gives people the opportunity to fund a project that they really believe in, with minimal risk. This engages a much wider group of people, who want to be in the forefront of great ideas or projects but may only have $20 to contribute. Crowdfunding lets everyone get in on the fun of investing in a new project.

One of the more popular crowdfunding sites is Kickstarter. Kickstarter’s funding process is simple. You’ll be given an opportunity to pitch your business to the Kickstarter community and if the crowd likes what they see, they’ll start providing the funds.

Don’t get this wrong. This isn’t free money; these are considered investors according tax law who expect to be paid back. But it’s a good way to get capital fast, especially for startups who have not had success in the traditional financing route with bankers.

How is this a good strategy for your startup? Consider these potential benefits of crowdfunding:

You’ll Get Instant Validation of Your Business Idea

Setting your business up for crowdfunding investment means you’ve really got to put yourself out there. Think of this as a kind of audition for your company. If you’ve got a great idea whether that’s for a restaurant, a dog grooming business or cleaning service you’ll know right away if yours is a good idea for this investment community. If no one bites, it might be time to rethink your business idea.

You’ll Sharpen Your Marketing Strategy

Many crowdfunding sites allow you to post videos or photos as part of your business pitch. Just like you’ll be instantly told whether your overall idea works you’ll also have an instant response to your marketing campaign. Yes, your pitch isn’t the same thing as a television commercial but you’re still tossing out what you think is the best approach to selling your product. The amount of money you receive will tell you if your pitch worked or not.

You’ll Get Help

By tapping into crowdfunding you are basically taking on many new business “partners.” This doesn’t mean that all the investors are going to be chiming in with how you should be running your company but there could be a vast amount of knowledge that you can tap into besides the investment.

For instance, a restaurant owner who is looking to expand their business might find a former restaurant owner among the crowd who can offer sage advice. There could also be a contractor which might offer a good deal on the work. The bottom line is that you just don’t know who might be in your crowd that will be a help for your business.

You’ll Get Better Organized

Anytime you seek out investors for a business you have to be organized. Investors want to know their money will be put to good use. This means providing a business plan and opening up your books for inspection. If you’re not organized then you’re not going to attract any type of investor. Knowing you’re going up on “stage” will get you organized rather quickly.