By Caitlyn Buchanan, 5th August 2020
Traditional funding methods such as bank loans, bank overdrafts, credit cards, and lines of credit have proven to be inefficient for many new startup businesses. Crowdfunding is an alternative to traditional methods of business funding. In this article, we take a closer look at the option of Crowdfunding for startup businesses and the benefits.
What is Crowdfunding?
Crowdfunding is the use of the internet and various social media platforms in order to raise capital for a business venture, product or idea. Hundreds, if not thousands of people can pool their money and support what they believe will be a successful venture. Crowdfunding for startup businesses is rapidly gaining momentum due to recent advances in technology, both in terms of application and availability.
Main Types of Crowdfunding
A common question that business owners have is ‘Does crowdfunding need to be paid back?’ The answer depends on the type of crowdfunding used. The 4 main types of crowdfunding for startup businesses are:
Donation Crowdfunding – This is often used by individuals or charitable companies seeking aid for a specific individual or cause. Donations do not need to be repaid.
Loan Crowdfunding– Also known as peer-to-peer lending. As the name suggests this funding is considered a loan and it is required to be repaid after the project is completed.
Exchange Crowdfunding– This is a common option for product development. Instead of repaying the funds, the company will give its lenders the finished product in exchange for contributed funds. However, if the company goes under or the product doesn’t get developed lenders will not receive anything for their money.
Equity Crowdfunding – This is the most common option for companies. The lenders will receive equity in the company in exchange for their funding. If the business model is successful, the lenders will own a part of a successful business. However, if the company goes under the funding doesn’t need to be repaid and contributors will lose their investment.
Advantages of Crowdfunding for Startup Businesses
One of the greatest advantages of crowdfunding is that the terms are set by the individual or business seeking funding. Crowdfunding has become so popular because there is little to no risk for entrepreneurs.
Example 1: John Doe would like to open a restaurant, however, he does not have sufficient capital. Due to the competition in the market, he fears he may fail and will be unable to repay the borrowed capital. As such, he decides to use crowdfunding as a source of capital. For those who invest, he promises to repay their money within 2 years along with discounts and free merchandise.
In the event that the business fails, John Doe is not required to pay back the money. However, people will expect him to live up to the promises he made when they provided funding. As such, he will still have to provide free merchandise and discounts, even if it is to another store.
Example 2: Jane Doe would like to launch a small custom t-shirt business. She realizes that it doesn’t require much capital but still, she doesn’t have the cash needed. As such, she resorts to crowdfunding, promising each donor equity in her company.
Is Crowdfunding Right for my Business?
One of the most important questions asked pertains to whether Crowdfunding is right for your business. The downside to Crowdfunding is that you don’t always have access to a large amount of capital. If the required level of capital isn’t reached, the money is given back to the lenders. However, a business can choose to use Crowdfunding to raise a portion of the required funding and seek the remaining amount from traditional means such as a banks loan or line of credit.
It is hard to say whether crowdfunding will be right for your business. The owners and founders must weigh the pros and cons to decide whether they believe they can generate the amount of capital needed. When done right, Crowdfunding can be an effective way for startup businesses to generate both capital and valuable PR.
Crowdfunding ensures businesses do not have to resort to burdensome and taxing loans. More information can be online, international Crowdfunding platforms such as Kickstarter.com have a strong reputation. In Ireland, local Crowdfunding platforms such as Linked Finance, iFundraise, and Fundit are gaining momentum and competing with the larger players in the global market.
<blockquote><strong><u>Disclaimer</u></strong><span data-preserver-spaces=”true”> This article is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Company Bureau for any action taken or not taken in reliance on the information set out in this article. Professional or legal advice should be obtained before taking or refraining from any action as a result of this article. Any and all information is subject to change. </span></blockquote>