Synopsis: Startups can use equity crowdfunding to raise money via the Internet – involving many small contributions which can add up to a large amount. This article explains the equity crowdfunding pros and cons versus other methods of capital raising, including personal savings, friends and family, government grants, bank loans, co-founders, incubators & accelerators, rewards crowdfunding, and venture capital. Armed with these crowdfunding pros and cons, readers will be much better placed to make an informed choice over which funding mechanism is right for them.
Rethinking Your Need For Capital
The best way to raise money is, and always will be, to sell things to customers.
That way, you get to retain control of the company and grow the value of it. So before you consider the equity crowdfunding pros and cons, first give careful thought as to whether you should be looking for outside funding at all.
Ultimately, all forms of outside financing rely on your ability to sell things to customers at some point. Debt investors are backing a company’s ability to sell things to customers that they can be paid back with interest. Equity investors are backing the company’s ability to build a system of selling things to customers so that their stake becomes more valuable. Offering debt and equity are effectively borrowing against future ability to sell things to customers.
The best reason to get outside investment is: your business may not have the luxury of growing slowly. If you operate in a fast-moving industry, opportunities can be fleeting — if you don’t get there first, someone else will. If you had started an internet search engine in the early 1990’s, you might have had a chance of gaining world pre-eminence, but if you tried to do it today, there is no chance you would be able to compete with Google.
The additional resources provided by outside investors will allow you to get to where you are going faster – whether that is through additional sales and marketing efforts, opening up new locations, or developing new products.
If that sounds like you, it’s definitely worth giving the equity crowdfunding pros and cons the thought it deserves – especially since equity crowdfunding’s characteristics actually allow you to multiply the effect of those growth efforts through the exposure it can provide.
If you want growth, then having investors is a great way to hold your feet to the fire. Having investors will force your business toward a more growth-oriented path.
Investors are like having a personal trainer constantly checking up on your progress and giving you a whip if you are slacking off. This added pressure and commercial discipline is not to everyone’s liking, but it can get you better growth results than self-motivation can.
Look At The Equity Crowdfunding Pros And Cons
Previously, I have explained how does equity crowdfunding work. But before you get too far down the path, you should evaluate equity crowdfunding against the many alternatives. What follows are the crowdfunding pros and cons, versus 7 different funding methods.
1. Personal Savings
We start this analysis of equity crowdfunding pros and cons with the most simple of funding methods – using your own money. “Bootstrapping” with personal funds is something that just about all company founders have needed to do at some stage.
One of the first questions that outside investors will ask is: ‘How much have you personally invested yourself?’ If you can’t show you’re taking a significant monetary risk, outside investors will probably be leery about giving you any of their money for you to play with.
If you are very young and have not had the time to build up substantial financial resources that you could use, then they might be more understanding. But investors want to see that you are personally invested in the venture before they will be willing to join you.
Using personal savings has the advantage of allowing you to keep full control of your business. But your frugality may be a hindrance to your venture’s potential and slow down your growth. Using personal resources is also riskier for you, because it is your money at stake, but this also means you will be more careful with it.
2. Family And Friends
One step beyond your own personal resources are the resources of those within your immediate circle. They know you, they can see your passion, and they may back your idea on more favorable terms than those further removed from you.
Even if your friends and family don’t insist on putting investment terms into writing, you should. Perhaps your family or friends think of a cash contribution as a gift, more than an investment – if that’s the case, that’s fine, but make it crystal clear what (if any) shareholding they gain. Don’t be scared to get a lawyer involved.
Also, consider the worst-case scenario and whether you and they are prepared to go through with that. Losing the capital of financial investors will not be a fun experience, but losing the money of family and friends can be downright miserable if it ruins relationships. Can you handle that prospect? Do your friends and family understand the risks? Think about all of this very carefully before you take money from those near and dear to you.
Actually, it’s not so much of an either/or choice when it comes to family and friends vs. equity crowdfunding. Even if you eventually decide that the equity crowdfunding pros and cons favor going down the crowdfunding route, then you’ll probably need to reach out to family and friends as potential investors.
3. Government Grants
In many places, generous government grants are in place to help businesses get their start. Some grants are conditional – for example, they could require you to hire a minimum number of local staff. You should definitely take the time to understand the implications of these conditions before signing up to a grant program.
But in many cases, government grants are literally free money to foster entrepreneurship and jobs. The government doesn’t become a shareholder, and it doesn’t expect you will repay the money in the future. Securing a grant is also a great credibility indicator when it comes to pitch to financial investors and equity crowdfunding platforms in the future.
4. Bank Loans
Borrowing money to grow your company costs in interest repayments, but this interest may end up being a lot cheaper than giving up a large piece of equity in your company at a low valuation. It is rare for companies to get bank financing at the very early stage, because they can’t offer enough security for the bank to become comfortable.
For startups, a bank loan might not even be on the table. You may be asked to personally guarantee the loan against other assets you have (such as your house). Personally guaranteeing a loan means you are effectively doing the same thing as using your personal savings – in both cases, the loss in the event of a business failure is yours to bear. For some entrepreneurs, putting their personal assets on the line is an untenable risk, which is why they seek equity investment instead.
Any time a company is founded with more than one person, different founders will bring different things to the table; you can have a programming co-founder, a marketing co-founder, a business-development co-founder … and you can have a financial backer as a co-founder too.
Those who contribute money instead of day-to-day work are known as “silent partners.” However, the best silent partners in early-stage companies are not silent! The best silent partners will help by determining the strategic direction – often financial backers are older, with experience, taking on a mentorship role. Or maybe they’re half-silent, working on the business part-time, but contributing extra capital. The possibilities are only limited to what is acceptable to all parties involved.
6. Incubators / Accelerators
Incubators and accelerators are for promising startups, providing a low-cost or no-cost shared office environment, support services, and often seed capital in exchange for equity. Depending on the quality of the program, the experience of being in an incubator or accelerator can increase the chance of a startup thriving.
Many founders find the environment of being around other startups to be invigorating, and these programs tend to facilitate a lot of learning in a short time. Incubators and accelerators usually require founders to apply and commit to relocating themselves to the premises for a set period. This can be disruptive to operations and isn’t for everyone.
Because incubators and accelerators focus on very early-stage companies, the amount of capital they can offer is usually quite low. Companies needing several hundred thousand dollars or more to expand already-proven businesses will need to look elsewhere.
However, companies that have been through the incubator / accelerator program can seek larger amounts of funding from contacts they make there; the introductions they can provide can help get a “foot in the door” with investors who have deeper pockets.
7. Rewards Crowdfunding
Rewards crowdfunding and equity crowdfunding campaigns look and feel similar to each other – both run crowdfunding promotion, have a ‘teaser’ video, a public Q&A forum, payments done through an online platform, and so on.
The difference is: rewards crowdfunding offers people the chance to back you in exchange for a reward (such as a product or experience), while equity crowdfunding investors get shares in the company in exchange for the cash. Lets look at the different varieties of crowdfunding pros and cons.
The biggest advantage of rewards crowdfunding is that the founders get to raise money without giving up any shares in their company. They gain customers, not investors, and therefore only need to deliver a product to them rather than have them around forever as shareholders.
There are also fewer barriers to launching a rewards crowdfunding offer, because your company will not be subject to such intensive checks from the platform, and there are fewer regulations involved. This means rewards crowdfunding can be used to raise smaller amounts of money, with fewer expenses.
And because rewards crowdfunding is often based around a product launch, you will get better feedback on the product than in equity crowdfunding. One thing that often happens in rewards crowdfunding is the backers will tell the company what features they want to see, leading to some very useful customer engagement while in the design phase. Your backers will tell you exactly what they want to see in the product they have backed.
The advantages of equity crowdfunding vs rewards crowdfunding can be summarized as follows:
- Equity crowdfunding typically raises a lot more money. While it is true that rewards crowdfunding campaigns have raised hundreds of thousands and even millions of dollars, this level of uptake is very uncommon. Anyone can launch a Kickstarter campaign, but not anyone can close one with a meaningful amount of money raised. You might be the one to beat the odds, but when it comes to raises in the six figures and up, the success rate with equity crowdfunding is much higher.
- Suitable for more kinds of businesses. Partly, the different crowdfunding pros and cons depend on the kind of business you have. Crowdfunding can work great for product development, but what if you are in the business of something that can’t be touched and bought? It’s pretty difficult to shoehorn a prosthetic limb business into a Kickstarter reward. Equity crowdfunding enables B2B businesses, more-established businesses, and businesses which aren’t naturally public-facing to raise funds.
- Expert feedback. Running an equity crowdfunding campaign will expose you to a more rigorous process than rewards crowdfunding. You’ll have outsiders look much more critically at your entire business as an investment proposition before you can launch. You’ll need to get your company strategy nailed down. You’ll need to have your shareholder agreement, company constitution, and share structure cleaned up. These processes are a lot of work, but they are highly valuable exercises in themselves – especially if you are hoping to be able to sell the company in the future.
- Valuation proof. One thing that owners really struggle with when selling their business is valuation, and justifying it to the buyers. An equity crowdfunding offer is a great place to kick off negotiations – if your campaign is successful, the public has validated an equity value for your company. A rewards crowdfunding campaign shows something different – mostly your ability to execute on marketing and that demand for your product exists. Some companies have used equity crowdfunding even when they don’t actually need the money, just to prove their valuation, prior to an initial public offer or sales process.
- Smart money. Some platforms will ask you to anchor your equity crowdfunding offer with a “lead investor” (someone from an angel or venture capital background, who contributes a large sum towards your goal as a way of validating the proposition). Having that “smart money” expertise in there can be a valuable source of contacts and advice. Rewards crowdfunding money tends to be silent on other areas of your business development – your rewards crowdfunding backers don’t really care if your business is making money, so long as they get the reward you promised them.
- Marketing benefits. Journalists are approached daily with requests to feature the latest rewards campaign of the day. Some have even added a filter to their email inboxes to send any email that contains the word “Kickstarter” or “Indiegogo” straight to their Trash folder. By contrast, equity crowdfunding platforms tend to have just a handful of offers “live” at a time, rather than hundreds or thousands, making it easier to stand out in a “crowded” media landscape.
- More enduring relationship. A more enduring relationship can be both a benefit and a curse. Pre-ordering a Kickstarter reward is one thing — the project will keep in touch with you while your reward is being delivered, but usually that’s it. But when you bring on an equity investor, the relationship is far more binding. It’s like the difference between dating and marriage. Decide which type of relationship you want to have with your backers when considering the crowdfunding pros and cons.
So there you have it – the equity crowdfunding pros and cons versus other methods of raising money for a startup! Now it’s up to you to decide which of them makes most sense for you and your startup.