Crowdfunding Crash Course for Small Business Owners

Crowdfunding Crash Course for Small Business Owners

Many small business owners and entrepreneurs are still finding that it is difficult to secure funding for their businesses or ventures. Yet, very few ever explore crowdfunding.

According to a recent survey, many business owners simply don’t know enough about securing capital from the “crowd.” Manta, which provides online resources for small businesses, found that just two percent of small business owners used crowdfunding to secure funding. However, 34 percent stated that they would consider the financing alternative if they knew more about it. As Manta highlighted, the survey findings indicate there is some confusion about the alternative funding landscape; there is a need for more information.

Entrepreneurs prefer not to leave money on the table.  Below is a brief overview of crowdfunding that may be particularly useful for small business owners seeking to raise capital.

Types of Crowdfunding

There are hundreds of crowdfunding sites on the Internet. While all of these platforms are slightly different, crowdfunding sites geared to businesses generally fall into one of the following categories:

•  Equity Crowdfunding: Funders receive an equity interest in the company in exchange for funding. Until the Securities and Exchange Commission (SEC) finalizes its long-delayed equity crowdfunding rules, most equity crowdfunding sites only serve accredited investors that meet certain net worth requirements. The agency’s proposed rules, which were mandated under the JOBS Act, would allow businesses to target the masses. In the meantime, several states have passed regulations that allow small businesses to sell shares to residents of the same state, without requiring that they meet accredited investor requirements.
• Reward: Investors who participate in rewards-based crowdfunding do not receive financial returns, but rather some form of tangible “gift.” Depending on the company’s business model, the reward may take the form of a t-shirt, VIP party access, a CD or a DVD. One of the most popular and well-known examples of this is Kickstarter.
• Lending: Lending-based crowdfunding, often referred to as “peer-to-peer” crowdfunding, most closely resembles a typical banking relationship. Investors make financial contributions in exchange for the right to receive reimbursement plus interest in the future. Prosper is one of the most successful lending platforms.

Costs of Crowdfunding

The costs of crowdfunding can vary widely. Nearly every crowdfunding site imposes a success fee, which is a percentage of the total amount of funds raised and must only be paid if the funding goal is met. Depending on the crowdfunding site, the cost may vary from 4 to 10 percent. Some sites charge equity interest and other fees, so it is always a good idea to do a cost comparison before selecting a crowdfunding portal.

With regard to equity crowdfunding via the SEC’s proposed rules, the cost is yet to be established. However, the agency’s rulemaking proposal did make some projections regarding the cost of regulatory compliance, which may include retaining a registered broker or crowdfunding portal to facilitate the offering, filing a variety of disclosures with the SEC, and providing investors with supporting documents, such as certified financial statements. According to the SEC, compliance costs associated with equity crowdfunding will comprise between 12.9 to 39 percent of the money raised for campaigns less than $100,000.  This needs to be revisited, as such high costs are not consistent with the job-creating purpose of the JOBS Act.

Selling Your Business Plan

Much like presenting your business plan to a venture capital firm, you must be prepared to demonstrate to your potential investors why your company is a good opportunity. Businesses need to show that they have the corporate structure and governance in place to provide a return on investment.

Since crowdfunding sites operate exclusively on the Internet, businesses generally will need to create a campaign specifically intended for online consumption, i.e. video product demonstrations, recorded messages from the company spokesperson, social media marketing, etc. In many cases, the companies that have the best crowdfunding success are those that are able to generate significant online “buzz” regarding their new product or service. Since crowdfunding also allows early interaction with your customers, it is also important to consider any feedback you receive along the way as a means to improve and/or retool your business idea.

Finally, as with any funding source, it is always important to do your homework. Partnering with advisers with crowdfunding experience, including business lawyers and accountants, can also help ensure greater success.