Funding is the fuel that aids in the smooth operation of any business. It is arguably one of the most imperative aspects that dictate a company's growth. Today, various modes of financing are available for a company when it comes to funding. However, the funding decision depends on factors such as the financial situation, type of business, loan amount, etc.One of the more popular and innovative funding options in the market today is Crowdfunding. In 2015, companies raised over $34 billion worldwide via Crowdfunding.
What Is Crowdfunding?
Crowdfunding refers to the method of raising funds wherein collective investors pool in small amounts of money to finance a business. It is typically done via the internet and is much simpler when compared to traditional sources of funding.
If a company were to raise funds traditionally, it would have to launch the product, develop a business plan, create prototypes, and then look for institutions or wealthy individuals willing to back the business. These sources could include banks, angel investors, or venture capitalists. However, it is a lengthy and tedious process and limits the options to a few key players.
On the contrary, crowdfunding platforms enable an entrepreneur to share a product/service to a wide audience in a single platform, thus streamlining and quickening the fund raising process.
Types Of Crowdfunding:
There are different types of crowdfunding. Depending on the company's products/services, business goals, the company's financial position, etc., a business can choose an option that best suits their financial requirements. The four primary forms of crowdfunding are:
- Donation-based – Any crowdfunding campaign that does not bear a financial return to investors is termed as donation-based crowdfunding. These types of funding generally include campaigns for nonprofits, disaster relief, medical bills, and charities.
- Rewards-based – This is where individuals invest in your product/service in return for a reward. The reward generally is in the form of the product or service itself. Despite this method offering a reward to investors, it is still considered a subsection of donation-based crowdfunding, since there is no direct financial return to the investor.
- Equity-based – This is where an investor becomes part owners of the company, receiving a financial ROI. They receive a share in the profit, unlike the methods mentioned above.
- Debt-based – In this type of campaign, the company or individual is fundamentally seeking to borrow money from individuals. The amount is then agreed to be repaid to the investors at a set tenure and interest.
How Does Crowdfunding Work?
It typically uses the internet as a platform to raise money for a variety of projects, causes, products, and services. For example, a start-up can use a crowdfunding platform to showcase their product. Many potential investors on the same platform can then choose to invest in this product if the terms are agreeable. In return, the investor receives a benefit (except in the case of donation-based), as mentioned in the business proposal. Once the goal is achieved, the fundraising platform then credits the money to the start-up, keeping a small percentage to itself as a fee.
Benefits Of Crowdfunding:
Crowdfunding for business is beneficial in the following ways.
- Efficiency – It is known to be more effective than traditional methods of raising funds, especially in the early stages of business, wherein a start-up may not be qualified or afford to take up seed capital via conventional methods. Setting up a funding campaign on platforms tends to be more effective.
- Builds Traction – An effective campaign can build validity and social proof. Subsequently, more people start backing your product, and this is imperative in building traction for your business.
- Marketing Exposure – A good campaign doubles down as marketing and media exposure. Crowdsourcing has become an excellent way to validate business and expose it to the market.
- Hedges Risk – Building a start-up can be challenging and risky. There always seems to be expenses, and finding sufficient funding can get perplexing. Crowdsourcing hedges these risks and allows an entrepreneur to gain market validation before going all out and starting up a company.
- Preselling Opportunity – It provides an opportunity to presell. The entrepreneur can list a business concept on a platform and presell a product that hasn't been taken to market yet. This method is useful in gauging customer preferences and market research.
- Free Platform – Crowdsourcing platforms are mostly free. However, it must be noted that a small percentage of the funds received will be deducted before it is credited to the business.
Disadvantages Of Crowdfunding:
Crowdfunding for business can be disadvantageous in the following ways.
- Not Suitable For Investments – It can be challenging to raise large amounts of money. Usually, one can attain a small amount of funds from a large number of investors. It may not necessarily be the most suitable strategy for larger cash injections.
- Low-quality Feedback – Since this method virtually permits anybody to invest, the quality of feedback a business receives is substandard. On the contrary, pitching to reputed, seasoned investors will earn you quality feedback, not only on the product/service but also the business model as well.
- Can Have A Negative Impact – In case the campaign fails, it remains on the platform for everyone to see. This lack of success is then likely to deter future investors.
Alternatives To Crowdfunding:
- Invoice Financing – Invoice financing is, by far, the most popular alternative to crowdfunding. The easy access, no-collaterals involved, and speedy disbursal, all make it a common and risk-free choice for businesses around the globe. In a nutshell, invoice discounting is a process wherein a company leverages its unpaid invoices in return for a short-term funding. KredX’s invoice discounting platform allows businesses to utilise their unpaid invoices to gain quick access to working capital.
- Asset Finance – This is a form of capital investment wherein a business obtains funds to buy or modify machinery. It is considered as a secured loan as the asset itself acts as the security. Therefore, this type of loan is relatively easy to obtain.
- Merchant Cash Advance – This is yet another alternative to crowdfunding. It is a form of unsecured loan wherein a lump sum amount of money is paid to a business in return for a stipulated percentage of credit or debit card sales.
FAQs on Crowd Funding:
A. While crowdfunding is a subset of crowdsourcing, there is a crucial difference between the two. The former refers to the process of sourcing money, the latter is the process of sourcing skills, information, or end products from a group of people.
A. To answer in short, it depends on the type of campaign and the terms and conditions. For example, a donation-based campaign need not be paid back while with a debt-based campaign, the money needs to be repaid.
Some of the inherent risks of crowdfunding for business are:-
- Underestimating the effort required to manage a campaign
- Not arriving at the correct price point
- Showcasing a product that is not apt for such a platform
- Undervaluing fulfilment costs
A. The upper limit differs from one website to another. There is no standard upper limit on crowdfunding projects.