How Crowdfunding Sites Can Work for Small Businesses
Welcome to our Creative Financing series, designed to keep you up-to-date on every kind of successful creative financing that comes across our desk! Our first installment takes a look at how crowdfunding sites can help small businesses grow.
Access to funding is perhaps the biggest challenge facing any entrepreneur—whether you’re just starting out, trying to grow, or adjusting to sudden and significant rent hikes. These challenges are even more marked, of course, for those small business owners who start out at a disadvantage for whatever reason.
Crowdfunding’s had a lot of hype, and it isn’t the answer for every small business looking for financing. However, according to a 2015 study, there’s been enough crowdfunding success to demonstrate that such “platforms can also serve as the basis for lasting businesses.” One reason for this is that small business owners can use crowdfunding sites for any of number of different projects or stages of a business lifecycle—seed money, prototyping, launching a new product/service, equipment replacement, and so on.
It’s not surprising, then, that in a 2015 Manta survey, over 30 percent of small business owners said they’d consider crowdfunding if they were better informed. To get the skinny on how small businesses can make the most of crowdfunding sites, we did some research. We also spoke with someone who’s run two successful campaigns: Nathan Johnson, Co-founder and Head of Operations and Innovation for JAKE, a bespoke and ready-to-wear luxury fashion and lifestyle brand in San Francisco. Following JAKE’s example, we’ll start with the essentials.
What is crowdfunding?
There are two different types of crowdfunding: rewards-based and equity-based. Rewards-based is the “original” type with which most people are familiar. Backers pitch in at a particular level and when the project is funded, they receive a reward, often a discount on a final product or exclusive swag.
Equity-based crowdfunding means you’re exchanging a bit of your company for funding, making it a more complicated proposition. This is a version of funding that’s been available privately, through traditional venture capital firms, for example, but for investors worth over $1 million, according to Securities and Exchange Commission (SEC) rules. Title III of the JOBS Act, which went into effect in May 2016, opened up this kind of investing to significantly more people by allowing it on a much smaller scale—the minimum investment on equity crowdfunding site Republic, for example, is $10. The maximum investment is 5 percent of your annual income or net worth (whichever is less) or $2,000, whichever is greater, per 12-month period. Equity crowdfunding must be handled by a “licensed broker-dealer or via a Funding Portal registered with the SEC,” in order to protect amateur investors.
People sometimes also refer to “debt crowdfunding,” but it’s easier to understand this kind of funding as peer-to-peer lending, rather than a type of crowdfunding.
Both rewards- and equity-based crowdfunding sites have associated fees, which vary by funding type and platform. Rewards-based platforms generally charge a fee (usually 5 percent of the funds raised) as do credit card companies or PayPal for processing. (There may be others. Always read the fine print!) Equity-based crowdfunding can be even pricier. “Startups can expect to shell out tens of thousands of dollars in legal and accounting fees to comply with the SEC rules, depending on how much they intend to raise,” according to FinTech researcher Jackson Mueller of the Milken Institute, quoted in Forbes.
Different crowdfunding sites also have different funding options. Kickstarter, for example, is an “all-or-nothing” model: if you don’t hit your goal, backers aren’t charged and you don’t get any funding. Indiegogo offers both all-or-nothing, or “fixed funding,” as they put it, and flexible funding. In the latter scenario, you keep whatever funds you raise, whether or not you hit your goal. Thus far, equity crowdfunding seems to be the all-or-nothing camp. Of course, if you need a minimum amount to fulfill the perks you offer backers, then you’ll likely need to take a fixed funding route, regardless.
Why crowdfunding is worth doing
Crowdfunding isn’t a loan, so despite the fact that it’s not, by any stretch of the imagination, free, neither are there going to be backend costs like interest. And, if you’re looking to raise seed money, crowdfunding can help you raise more than you might otherwise. The more businesses raise at the seed stage, the more they’re likely to get during first round funding.
Crowdfunding offers a number of benefits, but don’t think you’re getting something for nothing, for a couple of small processing fees, or even bigger SEC-compliance fees. Nate ran two successful crowdfunding campaigns for JAKE, their first on Kickstarter, in 2013, and the second on Indiegogo, in 2015. He says people tend to “underestimate how much work goes into crowdfunding.” Looking back, Nate reckoned that just launching their first campaign probably took two people working full-time for five days. An entrepreneur quoted in Inc. likened actually running a campaign to launching a company—so not for the faint of heart, apparently.
Fans love you more than your bank does
Crowdfunding can be a great option for entrepreneurs of whatever stripe who may have a hard time finding traditional funding. A recent study written up in the Harvard Business Review (HBR) found that crowdfunding backers “are often at least as good at making decisions as experts.” Generally backers and experts agreed, and “when they did not, the crowd was more likely to take a chance on projects than experts.” The kicker? Those projects “ultimately produced a higher number of critical and commercial hits” than those approved by the experts. Let’s hear it for the fans!
Entrepreneurs of color and women entrepreneurs, in particular, may have more luck with crowdfunding sites than older methods. While women entrepreneurs have a harder time getting bank loans or venture capital funding, for example, they outperform men in crowdfunding. “All else being equal, women are 13 percent more likely to succeed in raising money on Kickstarter than men,” according to the HBR study. Part of the reason may be that removing an institution (like a bank) from the equation allows several factors in women’s favor room to work. Women are often motivated to support other women, “especially when the female project creators are operating in a male-dominated space.” Successful women tend to be “persistent, good communicators, excellent at project management, and have good follow up.” An especially important factor in women’s success is that, according to research done at UC Berkeley in 2015, women are also telling better stories than men, “connecting at an emotional level” with potential backers.
Nate believes having a “heartfelt story” was central to the success of their (overfunded) first campaign. There are a lot of places people can put their money, he notes, and potential funders want to like the people they’re backing. JAKE’s 2013 campaign, back when they went by the name of Artful Gentleman, let its the company know that they had “found traction, that San Francisco was looking for something truly special.” The heart of that campaign was the company’s mission to revitalize the local craftsmanship of custom clothing.
Part of its appeal was not only the custom clothes being made, but employing skilled artisans locally to make them, and returning local space and equipment to their original use. The company continues to produce much of the brand’s signature clothing in San Francisco.
The benefits of community
Ultimately, the greatest benefit of crowdfunding sites is that they directly connect creators and entrepreneurs with their customers and fans. This direct line to your target audience has all kinds of associated advantages.
Think of crowdfunding as a kind of test-marketing. A successful campaign demonstrates demand and product-market fit. If your project doesn’t seem to be generating the enthusiasm you’d hoped for, you’ve got the most relevant group of people—your target audience—at your fingertips. Ask for feedback and make adjustments before you go to market.
JAKE’s second crowdfunding campaign, on Indiegogo, launched their post-Project Runway line, Five Easy Pieces. Nate noted that crowdfunding is a great way of testing a new product, gauging the reaction of your already-loyal customers, as well as reaching a new audience.
And while you’re discovering that your product resonates with people, you’re simultaneously building a community not just of backers but of cheerleaders for you and your business. Indeed, some successful crowdfunders think of the process as a “customer discovery tool.” Folks who are willing to fund you and your project, who have literally invested in your dream, will be more forgiving of hiccups along the way, as well as more willing to spread the news and be your brand evangelist.
For JAKE, creating that community, in part through crowdfunding sites, has meant being to able to watch their early customers’ personal style grow. The process, Nate says, holds you “accountable” to “people who support you and stayed with you through the years.”
Something Nate mentioned to us more than once is how much the process of a crowdfunding campaign can teach entrepreneurs “about what [they’re] trying to do,” about their product or service, and how to market it.
How to have a happy crowdfunding
Know what to ask for. If you’re at the beginning of founding a business, “break down your funding into phases and establish a goal that makes sense within each phase,” suggests Wil Schroter of Fundable. Don’t try to fund everything at once. Reliable estimates based on due diligence “signal to the crowd reviewing your offering…that you didn’t just ‘pull a number out of the sky.’”
Research successful campaigns—Nate advises looking at both overfunded and struggling or failed campaigns. “There will be an immediate difference” between the two, he says.
Choose the right platform – Know what you’re (and who) you’re looking for. Exclusivity? Traffic? Audience? The first time around JAKE went with Kickstarter because it was the most well-known. The second time, they used Indiegogo because it offered different financing options; Kickstarter had become flooded, making it hard to stand out.
Start by building an outline of the campaign, advises Nate. By the time you launch, you need to have all the pieces of the campaign ready to go: a clear, concise message, images and videos, a story that makes sense, and the manufacturing on the backend ready to go. And remember, as Simon Sinek said, “People don’t buy what you do, they buy why you do it.” Make it a good story.
Likewise, you should start generating interest as soon as possible. The more “built-in” backers you start with—friends, family, community, existing followers—the better. These folks will be funders and promoters. Let your network know that the campaign is coming and to stay tuned. Nate suggests getting on a blog and finding other ways to “tease” your network.
One way of making sure that you build a solid foundation on which to build your campaign is to “make the goal community development, not raising money.” For example, the Exploding Kittens Kickstarter campaign “challenge[d] their fans to recreate various scenes [from the game] on their cards and post them on Instagram with the right hashtag.” A little virality never hurts (at least not a crowdfunding campaign).
Nate warns potential crowdfunders to make sure the reward matches the contribution, and that you can afford whatever you’re offering. Crowdfunding isn’t much help if you lose money on the campaign.
Major crowdfunding sites
Among the rapidly proliferating crowdfunding sites, some will be more appropriate for your needs than others. Make sure that you know all the ins and outs of your chosen platform. And if you’ve got “extra” money to invest in your crowdfunding campaign, there is a growing number of companies like Peerbackers, who will help your campaign succeed.
Right now some of the majors players are:
Fundable (reward and equity)
Fundrazr (reward and equity)
Crowdfunder (equity funding)
Portfolia (equity, focus on social entrepreneurship)
Before you go, good to know
The Small Business Association has a free 30-minute online course that will introduce you to crowdfunding for entrepreneurs.