Which Type of Financing is Right For Your Startup? The Pros and Cons of Equity Crowdfunding
Having a great idea for a business is one thing. Getting the financial backing to grow, scale and make it a success is quite another.
Most entrepreneurs approach funding in stages, starting by dipping into their own savings, going cap-in-hand to friends and family, taking advantage of government grants, crowdfunding and potentially seeking angel and venture capital.
The best funding option depends on the business, its track record and growth plans. Some companies stay self-funded forever, while others need the capital injection and expertise from outsiders. Getting the right investment, in the right sums at the right time can often make the different between a startup’s success or failure.
Techvibes has put together a list of common investment options for startups, and pros and cons or each. It will cover the following:
- Government grants
- Angel investing
- Equity Crowdfunding
- Venture Capital
Crowdfunding, again, is a way for startups to raise small sums of money from a large amount of people. With equity crowdfunding, unlike the rewards-based kind, investors get a stake in the company. Their reward is the profit they expect in return for giving you their money.
Until recently, only accredited investors could get in on these private deals in Canada. New regulations across Canada allow regular investors to participate, with various limits depending on which province they live in.
Equity crowdfunding is filling a funding gap that startups and investors alike have complained exists for early-stage companies. Startups like FrontFundr, a Vancouver-based equity crowdfunding platform, are also cropping up to help connect companies and investors.
Below are the pros and cons of equity crowdfunding for startups.
Access to capital: New rules have opened up the number of people who can invest in your startup, which potentially means more dollars to back your big idea. “You can raise a large amount of money in potentially short period of time … and in a regulated market,” says Craig Asano, founder and executive director of the National Crowdfunding Association of Canada. It’s also a good option for startup that may be too early-stage to secure funding from traditional banks.
Transparency: The bonus with new equity crowdfunding rules is that the process is more open and transparent, Asano says. That’s good news for investors and startups because it builds confidence in the system, especially as Canadians become more familiar with the alternative funding and investing model. It also forces startups to get better organized for future funding rounds.
Your business grows faster: Once you’ve tapped the crowd, you can use the funds to grow your business more quickly. Maybe you spend it on R&D, new employees, marketing, or manufacturing to get your product on the shelves sooner. Either way, there’s nothing like money to speed up the pace of business.
It’s complicated, and costly: There are a lot of rules and regulations around equity crowdfunding, and making sure you’re on side with regulators will take a lot of time and money, including getting the proper legal advice for your business. It’s especially complicated given that regulations in Canada vary by province, so what you do in Ontario will differ from in B.C., which will differ in Alberta. “You need to make sure it’s worth the return and all of the effort,” says Asano. “It’s really for companies that are raising capital regularly, because they have to fuel an expansion model or a growth-oriented business.”
Too many cooks: It’s great to raise a lot of money from different people, but remember that with equity crowdfunding they’ve got ownership too. That means a lot of people to keep updated, to satisfy and eventually – if all goes well – to pay if your product or service is a success. Some investors may also be very vocal in their opinions about how you run the business. “With any business, taking money from investors can be very stressful with regards to managing an investor base that is quite demanding,” Asano says. “It’s different when you are giving equity away, as opposed to a rewards-based model.”
Lack of expertise: Many investors you get from the crowd are unlikely to add value beyond their chequebooks. You could potentially be missing out on the experience and mentorship that can sometimes come with other forms of funding, such as angel or venture capitalists, most of who have been in your shoes in the past.
According to an article by angel investor Christopher Mirabile, equity crowdfunding is ideal for first-time entrepreneurs who can’t raise from larger investors, companies that need funding for a specific product or project and one that could benefit from a broad fan base. Mirabile says it’s less ideal for those who need industry expertise, mentors or other value-added investors that can help open doors to other investors or in the industry in general. Understand your long-term business goals before choose the equity-crowdfunding route.