Accessing capital is always a challenge for business owners. Traditional financing methods involve tailoring pitches to specific financiers like venture capitalists, angel investors, or bank loan officers, a process that can be extremely time consuming.
One alternative financing option has gained increased steam over the past few years: crowdfunding.
What is crowdfunding?
Crowdfunding, or crowdsourcing, uses fundraising campaigns to raise smaller amounts of capital from larger numbers of backers than in the conventional funding model. In crowdfunding, projects can raise anywhere from one dollar to over two-thousand dollars from a single backer. The contributions may be individually small, but can add up to one large lump sum in the end. Crowdfunding usually takes place through online platforms, but is not limited to the wired space.
Crowdfunding can fund a variety of things. The online platform GoFundMe is used for personal fundraising to finance costs of medical equipment, surgeries, or college tuition. Crowdfunding can also fund creative projects like films, plays, books, health products, and technology. The state of Alaska recently turned toward crowdfunding to pay for a riverbank project during the middle of a state-wide fiscal crisis. Crowdfunding can even be used to get a business or arm of a business off the ground.
Instead of crafting tailored pitches for several different investors, crowdfunding allows development of a single pitch for just one, large audience. Crowdfunding campaigns can basically reach anyone with internet access. Crowdfunding allows the everyday person to invest in products or businesses that they are passionate about. It exposes a wider range of financial options and previously untapped capital to creatives, entrepreneurs, and small business owners. As opposed to traditional financing, you don’t have to be an accredited investor to participate in crowdfunding.
Equity, or investment, crowdfunding is one mechanism that entrepreneurs can utilize to finance their business. With this mechanism, business owners can raise capital by actually selling equity, or shares, of their company to but accredited and non-accredited investors. Typically, purchase of securities is limited to accredited investors, which in the U.S. is the wealthiest three percent of the population. Equity crowdfunding allows the everyday American to invest in local businesses that they are passionate about.
A law permitting equity crowdfunding within Minnesota, called MNvest, was just passed this June. For more information, please visit MNvest.org.
Reward Based Crowdfunding
Most people are more familiar with reward based crowdfunding, where financial backers receive some kind of tangible incentive for funding a project or business instead of equity. Similar to something like the Minnesota Public Radio (MPR) model, in reward based crowdfunding backers receive a reward or prize for hitting some set donation tier, whether that is one, five, twenty-five, or two thousand dollars. Prizes can be anything from a hand-written thank you note, sticker, shirt, or early release of a product. The incentives just cannot be equity.
Kickstarter’s mission is “to bring creative projects to life”. This online platform was launched in 2009. Since that time, Kickstarter has had 11M people back projects, raising $2.6B.
Kickstarter projects must create some kind of sharable project; it’s not a platform for personal or charitable fundraising.
The essential components of a Kickstarter campaign include: a page containing the project description, including a video; rewards for backers; and updates of the campaign and project progress to backers.
Kickstarter follows an all or nothing financial model. Users set a goal amount that they want to raise. Kickstarter recommends careful calculation of all the costs it would take to minimally fund the project, plus deliver the rewards to the backers. Remember to include packaging and shipping costs! If the campaign doesn’t reach the set financial goal, all the money is returned to the backers.
Kickstarter crowdfunding campaigns last between thirty to sixty days. The service does charge a five percent fee for using the platform and has additional payment and processing fees.
Indiegogo is similar to Kickstarter and serves as a “launchpad for creative and entrepreneurial ideas”. This online platform was launched in 2008 and has thus far raised $950M from 11M backers to finance 650K projects.
Indiegogo features both flexible and fixed funding. The fixed funding method is all or nothing, similar to Kickstarter. But with flexible funding, all the invested funds are retained even if the financial goal is not hit.
Indiegogo offers a free pre-launch feature to help elevate hype around the project before the campaign launch. Indiegogo also has a market place platform, where successful campaigns can sell their product after the campaign has finished. Both the crowdfunding and market place features charge a five percent platform use plus additional processing and payment fees.
While crowdfunding is an attractive mechanism to raise capital, one study suggests that less than one-third of the campaigns reach their target. Even if a campaign is successful, it doesn’t guarantee that the business or product will work.
Crowdfunding is an art and there are key components to a successful campaign. There are some great examples of crowdfunding campaigns that were launched in Rochester. Over the past few months we spoke with three Rochester entrepreneurs who ran crowdfunding campaigns, all on Kickstarter. Some were successful. Some were not. Join us as we talk to these local innovators and learn from their mistakes and successes.
We already featured a podcast with Adam Ferrari and his experience running a Kickstarter campaign to fund a mobile design studio, called Charette Happens. We also spoke with Sean Baker, who used Kickstarter to finance the continued operation of The Med City Beat plus a documentary and extended interview series. Our crowdfunding series also features AJ Montpetit, a local entrepreneur who launched a campaign for the World’s First Free Stock Drone Video Site.