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What is crowdfunding and how will it help my business?

September 26, 2012

Crowdfunding has been a popular subject of conversation among entrepreneurs lately, and with good reason. It opens up exciting new opportunities for financing your latest endeavor. In addition, the recently passed JOBS Act (Jumpstart Our Business Startups Act) has made it so businesses will (in early 2013) be able raise up to $1 million per year without having to do public offerings.

This regulatory change should make it easier for small businesses to use this method of attracting investors.

Crowdfunding gives entrepreneurs an alternative to bank loans or utilizing personal credit…

So, what is crowdfunding? Is it right for every business? And, most importantly, how can your business benefit from it?

Crowdfunding: What It Actually Is

Crowdfunding can basically be defined as the cooperative pooling of investment capital by groups of people in order to finance the undertakings of others, in exchange for a benefit of the business (more on that in a moment.) Crowdfunding has been used to finance independent music and films, provide disaster relief,  bolster scrappy political campaigns, and yes, fund a great business idea.

And the cool thing is that instead of paying people back with money, when you crowdfund, you pay them back with a “benefit” of your business. A sandwich shop for example may repay that $500 crowdfunding pledge by naming a sandwich after the “investor.”

Popular crowdfunding sites include IndieGoGo and Kickstarter.

Effect of the JOBS Act

The JOBS Act expands crowdfunding by allowing small businesses to raise funds through larger groups (up to 2,000, 500 of which needn’t be accredited) of smaller investors than was previously possible.

This has also lessened the financial risk for each individual investor, and opened the gates for investors who might not have been able to participate before. It also gives entrepreneurs an alternative to bank loans or utilizing personal credit to get a new business off the ground.
Pledges Versus Investments

Example: Let’s say you are trying to raise funds to create a new CD for your band. In essence, you’re selling a product, but you’re also dealing with people who are emotionally invested in the outcome – your fans. So a return on their investment might be an autographed copy of the album and a sweaty bandana you wore on tour, or some used guitar picks should do the trick. Investors probably won’t be too interested in your financials or your credit rating (you’re a struggling musician, after all).

If you’re crowdfunding a business venture though, you’ll need more than a catchy song. You’ll need to convince your investors that your project is a worthy investment, just as you would when applying for a small business loan through a bank.

First, you should create an enticing business plan that will assure your investors that you have thought things through. Make sure the pertinent information is available for them to peruse. Also, bolster the credibility of those involved with running the business by providing bios and references for the management team.

Second, you will need both a catchy video for the crowdfunding site so as to attract attention, and a great benefit that your people will want to get for believing in, and putting money up for, your business.
Is Crowdfunding Right For You?

There are several things you should consider if you’re thinking about crowdfunding your business or project.

  • First, if your business will require a lot of startup capital, crowdfunding may not be the best solution. It typically does not result in 6 figure outcomes
  • Second, you should have a plan in place for how you’ll communicate if you are fortunate enough to get a lot of investors.
  • Third, your investors will want to know what they’re investing in, but be careful not to expose trade secrets to your competitors.
  • Fourth, you should consult with a business lawyer to make sure everything is above board.

But if you do those things and offer your people both a compelling reason to invest in your project AND a great benefit for putting up some money, there is no reason you cannot crowdfund your next brainstorm.

For more information on crowdfunding and other creative funding options, check out Steve’s book Get Your Business Funded.

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