Which Type of Financing is Right For Your Startup? The Pros and Cons of 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 for each. It will cover the following:

1. Bootstrapping
2. Government grants
3. Angel investing
4. Crowdfunding
5. Equity Crowdfunding
6. Venture Capital

CROWDFUNDING

Crowdfunding is a way to raise small sums of money for your startup from a large amount of people. The funding concept dates back centuries, but modern-day crowdfunding is being fueled by the Internet and proliferation of social media. Dozens of online crowdfunding platforms have cropped up in response to a growing number of entrepreneurs looking for alternative ways to fund their startups, and more investors seeking alternative places to put their money.

There are two main types of crowdfunding: rewards-based and equity. In this article we’re dealing strictly with reward-based crowdfunding, which is when entrepreneurs presell a product or service without providing equity or shares to investors. Well-known reward-based crowdfunding platforms include Kickstarter and Indiegogo, to name just two.

Some examples of successful crowdfunding campaigns include The Veronica Mars Movie Project, which raised more than $5.7 million (U.S.) in 2013, and Corner Gas: The Movie, which raised a more modest $285,800. It was also a Kickstarter campaign that launched the Vanhawks Valour smart bike. That story didn’t end well, however, with the company last reported to be on the verge of shuttering.

Below are the pros and cons of rewards-based crowdfunding.

Pros

Low cost, low risk for founders: Let’s say you have a great idea but you don’t have the money to find out if it will sell. Crowdfunding allows you to test that theory by launching it on a crowdfunding platform and investing a few marketing dollars to promote it there and on social media.

If the money doesn’t come, at least you haven’t invested your life savings (presumably) and can go back to focusing on your day job — or your next big idea.

Immediate cash injection:  If you’re idea gets enough financial backing, you can start building your product or service right away.

“Money is the fuel to not just start, but to grow,” says Craig Asano, founder and executive director of the National Crowdfunding Association of Canada. Of course, it’s best to have a budget first to figure out how to spend the cash and increase your chances of being a success.

Instant network of buyers and investors: Through the act of raising money through the crowd you’re automatically generating consumer and investor interest, which hopefully translates into future sales and investment.

“Crowdfunding improves access to cash, but also the crowd — a vast network of potential investors, buyers and supporters who contribute their resources to help realize a project,” says Asano. “It all plugs into an ecosystem that is vying to help companies succeed.”

Cons

Pressure to deliver: Now that you’ve raised the money, you need to deliver the product on time — and for your sake, on budget. This is the most stressful part. Not only are you spending a lot of other peoples’ money, but they’re tapping their fingers waiting to see the results.

Your job is to deliver the product as promised, when promised, or start coming up with plausible excuses as to why you can’t.

Everyone else is doing it: There are a lot of great ideas being pitched on crowdfunding platforms today. What makes yours special? Why should someone pledge their money with you, and not the other startup?

“It’s hard to stand out from the crowd,” says Asano. He says startups need to find ways to better compete for crowdfunding dollars, and lure people to their crowdfunding page.

Lots of work with potentially no payoff: We hear a lot about the crowdfunding success stories, but not as much about the failures. Many startups don’t raise enough money through crowdfunding, and have to go back to the drawing board. It can be soul crushing.

“You could go through a lot of work and raise a goose egg,” says Asano. “That kind of hurts. You have to take that in stride. Either you need assistance with online marketing, or the product you though was the bees knees of XYZ wasn’t.”

Takeaway

Rewards-based crowdfunding is a great way to raise money with no string attached. However, it’s not as easy as launching a page and watching the dollars roll in. Startups looking at crowdfunding need to be strategic about how they market online, what they offer investors as incentives, and how they’ll produce and deliver the product to generate happy customers in the end.

After all, for many startups, crowdfunding is the first stage of a larger growth plan. It’s important to try to get it right the first time.