What are the types of crowdfunding for small businesses?
Introduction
Many small businesses find themselves unable to secure loans from banks and other lenders. In this, they fund themselves at a disadvantage when compared with larger companies. Community fundraising can be used as a?tool to help these smaller businesses grow and survive.
This article explores the four main types of crowdfunding available to small businesses and helps entrepreneurs decide which option is best suited for their situation.
An example
Let's say there’s a local pizza shop on your street. You've known the owner (let’s call her Sarah) for a long time, and you trust her because the shop always provided great service to you and friends. She wants to open another location — but doesn’t have enough capital to do so.?
Sarah had gone to a few banks and applied for financing online. Each time she’s either been rejected for a loan - the underwriter thought that the business has not been in operation long enough. An online lender did give her an offer for a loan, but the interest rate was too high.
What if Sarah could raise the capital from you and others in her community? If the terms were attractive, perhaps you and others would want the opportunity to become investors or contributors? That could be a win-win scenario!
Small Business’s Crowdfunding Options
There are various types of crowdfunding, and each is effective in its own way. When preparing to run a crowdfunding campaign, small business owners need to make sure that they have a clear understanding of the type of crowdfunding that will be best for a business.
There are three main types of small business crowdfunding: rewards-based, debt-based, and equity-based. Revenue-sharing crowdfunding campaigns have recently also become popular for small business fundraising.
In the following sections, we outline various types of crowdfunding. Then, we include instructions on conducting a data-based funding portal selection process. We are in the process of building a funding portal selection tool (among other crowdfunding campaign-enabling features), to join the waitlist for access to this and other crowdfunding enablement tools, please enter your email?here, on our main page.
Reward-based?
People who contribute to a business’s rewards crowdfunding campaign receive tangible perks. These can include anything from discounts on future products to special merchandise made just for supporters. Some intangible benefits can also be provided such as gratitude listings on the business’s website or as a placard at the location.
Let’s go back to Sarah’s example: she could offer the community a chance to pay for the pizzas upfront and receive them when the new location opens. She could also provide select contributors opportunities to host their birthday party or another event at the location.
The rewards a small business offers to its campaign’s contributors can strengthen the connection with the community and help to improve the business’s marketing efforts.?
For example, through crowdfunding on Kickstarter, the business owner might be able to collect important feedback from their community about their service — and create products that are better tailored for their supporters. The exercise of reaching out to the community should improve brand awareness and help to generate more revenue.
Debt-based?
Debt-based investment crowdfunding involves raising funds by issuing loans to investors in exchange for interest payments (and rewards-like perks). The small business is expected to pay back the loan within a specified time period (around 3-5 years). It can be more practical than seeking loans from banks or online lenders since the business owner can choose the interest rate and other terms of the loan.
For example, Sarah’s pizza shop might borrow money from the community investors in order to open up a new location with an agreement that she would pay back the loan after several years along with agreed interest.
This way of financing the business includes the marketing and community research benefits of rewards crowdfunding but may allow the business to raise more capital it otherwise would have. It also does not tie them to producing specific products. On the other hand, it creates the financial commitment of repaying the debt with interest.
Revenue-Sharing
Revenue-sharing crowdfunding is a form of debt-based crowdfunding that allows small businesses to raise capital and pay back to the investors, depending on their revenues.?
According to Crowdfunding Capital Advisors, “Revenue Share means that a company will pay back its investors a percent of gross revenues each month until the stated return is made. This return could be within a specific time window or until the stated return is met.”
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Let’s imagine that Sarah’s pizza shop is in a beach town. During the summer months, the pizza shop earns significantly more revenue than in other seasons due to the inflow of tourists. If Sarah used a regular debt-based solution, her regular payments would remain fixed; this may pose a cash flow problem during the months when the business activity slows down.
Using a revenue-sharing debt agreement would allow Sarah to pay investors back in accordance with the pizza shop’s profits. To do so, she would have to work with her accountant, lawyer, and funding portal representatives to determine the right maturity date & investment multiple for this type of debt.?
Yet, Sarah would need to take care to structure her payments to investors correctly - if the note matured prior to full repayment, the investors would be able to seek repayment through legal means.
Equity-based
Equity-based crowdfunding is when investors exchange ownership equity for funding. Equity received by investors may take the form of stock in a company—and can include perks such as dividends and voting rights.
This type of crowdfunding could be used to help prevent adored small businesses from failing as community members buy shares in partial ownership. In theory, Sarah could raise capital by selling shares in his company to customers.?
However, usually investors contribute to equity-based crowdfunding campaigns, expecting an eventual sale of the business. Therefore, this form of crowdfunding is preferred by technology companies, looking to eventually become listed on the stock exchange or to be acquired. Small businesses do not typically use this form of crowdfunding.
Selecting a funding portal
There are fewer options available for selecting rewards crowdfunding platforms, which makes the process easier. The rewards crowdfunding mainstays offering similar services are:
For investment crowdfunding portal selection, the process is considerably more complicated, with higher stakes. There are over 70 FINRA-registered investment crowdfunding portals in the United States. They have varying conditions, approval rates, and specializations.
To de-risk your funding portal selection process, we recommend business owners to:
1.?Go to?https://kingscrowd.com/companies/search/?- Kingscrowd is the leading provider of investment crowdfunding information for investors
2.?Consider the filtering options that you see before you:
3.?Enter the corresponding filtering options
4.?Look through the profiles of the businesses that resemble your business, while paying attention to the funding portal that they used to raise the funding.
Take note of the total amount of capital that the campaign raised, the type of investment crowdfunding it used, the number of investors. Looking at the business’s website, Facebook and Instagram accounts of these companies will also add more colour to your analysis for choosing a funding portal.
In general, the following FINRA-registered funding portals specialize in small business investment crowdfunding:
Conclusion
There are many types of crowdfunding, and it can be difficult to choose the right one for your business. It's important to keep in mind that each type comes with its own benefits and drawbacks.?
Rewards-based crowdfunding offers tangible benefits to contributors; it's considerably less complicated than investment crowdfunding yet commits the business to deliver specific benefits. Debt-based crowdfunding is also a good tool for small businesses, and it carries fewer commitments to delivery of benefits but binds the business with the financial obligation to pay back the principal and the interest to the investors. Revenue-sharing crowdfunding is a type of debt crowdfunding that is useful for small businesses that experience cyclical growth and need flexibility in the loan repayment process. Equity-based crowdfunding is not often used by small businesses because of the difficulty of ensuring a return on investment.
We hope that Sarah’s trials and tribulations were not in vain - and that this article will help you on your path to making the right decision to fund your business. To make the selection of the right crowdfunding tool easier, we are building Kupchiy. It is a product that aims to simplify the investment crowdfunding process for small businesses. To receive early access to our product when it is ready, please sign up for the waitlist?on our homepage.