Securing startup funding can be a barrier for entrepreneurs trying to get a new business off the ground. For many owners, the idea of asking a bank or single lender for thousands or even millions of dollars adds an entirely new layer of stress on top of the already overwhelming task of launching a business. It’s also not an easy process. Proving to a lender that your idea is worth his or her investment is rarely an easy sell.
For all of these reasons, more and more entrepreneurs in recent years have shifted from traditional funding to crowdfunding to get the money they need to bring their product or service to market.
Crowdfunding has shifted startup fundraising from a single-lender model to a collective virtual effort, giving a startup financial support while instantly introducing the business to potential customers.
According to SCORE mentor and business attorney Chris Dargie of Portland, Maine, crowdfunding has rapidly become an accepted way to raise capital for small businesses.
“Traditionally, companies raised capital by issuing debt or equity,” Dargie said. “Rewards-based crowdfunding introduced a completely new alternative. The model has shown that the public is willing to contribute capital to worthy projects without any expectation of future profit, which is quite revolutionary.”
While crowdfunding is a great way to finance your startup, it’s not a silver bullet. According to Dargie, there’s a right way to approach this type of funding. Here are his suggested Dos and Don’ts of crowdfunding.
Understand different types of funding
There are three primary types of crowdfunding, each with different goals and risks:
Rewards-based crowdfunding — asking your backers for capital in return for an incentive
Equity crowdfunding — giving away equity in exchange for capital
Peer-to-peer lending — taking on debt that you’re legally obligated to pay back.
Before you get started, you need to have a full understanding of the type of funding you’re looking for and the amount of risk you’re willing to assume.
Select the right crowdfunding platform
Don’t automatically select the platform with which you’re most familiar. Each crowdfunding platform is set up to serve a different purpose and audience, so choose the one that fits best with your business type and goal. Some of the most commonly used crowdfunding platforms out there include:
Kickstarter — the big name in crowdfunding for tech and creative entrepreneurs
GoFundMe — the best for personal fundraising
Indiegogo — great for tech startups and community projects
Causes — built for nonprofits
Patreon — great for creatives and designers
CircleUp — ideal for equity funding for consumer brands
LendingClub — a go-to for business loans
Fulfill your obligation after your launch
As crowdfunding has grown as a serious startup funding option, so has the attention of government consumer protection bureaus towards these platforms. Deceptive crowdfunding campaigns are quickly shut down and fined. Know the rules and play by them so you don’t find yourself fighting a legal battle while trying to get your business off the ground.
Fail to manage expectations
Delays in business are inevitable, especially for a startup. When you’re promising a product by a certain timeframe during a crowdfunding campaign, don’t overpromise. Manage the expectations of your backers by keeping them in the loop as your business progresses, and set realistic timelines along the way.
Launch a campaign before forming an entity
You need to legally form your business entity before you begin your crowdfunding campaign. “You don’t want to be left holding the bag personally if your business has spent all the money on development and has nothing to show for it at the end, and the backers want their money back,” Dargie said.
Forget to pay taxes on funds raised
Rewards-based campaigns bring in cash typically viewed by the IRS as taxable business income. For this reason, Dargie advises businesses to consult with their tax advisors before beginning any crowdfunding campaign so you know you’re covered before you begin.
Crowdfunding is a great way for entrepreneurs to get their businesses launched fast without relying on a bank or single lender. Like any means of fundraising, though, it comes with its own risks and hurdles. Do your research and consult other professionals who have been through the process, such as a SCORE mentor. A SCORE mentor will work with you to start the crowdfunding campaign, find a financial advisor who can support you, and help you put the funds to work immediately to launch your business. Contact a SCORE mentor today.
Since 1964, SCORE “Mentors to America’s Small Business” have helped more than 11 million aspiring entrepreneurs and small business owners through mentoring and business workshops. More than 10,000 volunteer business mentors in more than 250 chapters serve their communities through entrepreneur education dedicated to the formation, growth and success of small businesses. For more information about starting or operating a small business, call 1-800-634-0245 for the SCORE chapter nearest you. Visit SCORE at score.org.