Nowadays it seems like everyone is setting up a GoFundMe account to raise money for reasons such as medical treatment or natural disaster relief (personal crowd-based fundraising). But did you know that crowdfunding can also be a great resource for small businesses?
Small businesses and startups often do not qualify for traditional bank loans or other types of financing. this doesn’t mean they don’t have potential; they just need to find alternative means of fundraising. For some, rewards-based crowdfunding is the answer.
A crowdfunding campaign is a way to obtain funding from a variety of individuals, including friends and family (and sometimes even strangers) typically through the internet. It is typically centralized on an online platform and is marketed through social media and other online avenues. There are four primary types of crowdfunding:
Personal crowd-based fundraising (such as personal appeals for assistance as a result of an illness or natural disaster relief as noted above)
Equity crowdfunding (investors receive equity in exchange for their contribution)
Peer-to-peer lending (similar to a bank loan, but the borrower makes an interest payment to investors)
Rewards-based crowdfunding (some sort of incentive is given to contributors)
While all options are available to small business owners, the most popular method for crowdfunding is rewards-based, especially for very new companies. Rewards-based crowdfunding can even be used by a person simply with an idea and nothing else.
What is rewards-based crowdfunding?
In rewards-based crowdfunding, small business (or new idea) owners solicit money from individuals and, in return, promise to provide some sort of reward or incentive. Any person can contribute to the campaign and “back” the company. In most cases, the incentive given to contributors is the product or service that the business provides (or plans to provide). It could be a tangible reward, such as a pair of sunglasses or a cleaning service, or it could be an intangible reward, such as a new phone app or an online book. Some campaigns merely offer a thank you note in exchange for a contribution–which feels less like a reward to some contributors.
How does rewards-based crowdfunding work?
While every crowdfunding campaign is unique in its own way, most operate using similar processes. To utilize this type of crowdfunding, a small business owner first creates a campaign on the crowdfunding platform of her choice. There are a variety of platforms; some big hitters are Kickstarter, GoFundMe, or Indiegogo. Platforms often charge a processing fee and some take a percentage of the funds raised (typically between 5-13%). Each crowdfunding platform comes with its own perks–and drawbacks–so every business owner should assess her needs and do some research before choosing a platform.
In creating the campaign, the business owner will set a fundraising goal and a deadline for when fundraising will close. In most cases, if the business fails to reach its goal by the deadline, all those who gave money will be refunded and the business walks away with nothing. Individual contributions are often small, meaning that, to run a successful crowdfunding operation, the business needs to persuade a lot of people to provide enough funding to reach the business’s goal.
But persuading people to participate in a a crowdfunding campaign is no simple task. A business needs to clearly communicate its purpose in raising funds. Contributors want to know details about the new product, service or idea before they pledge to support it. Promotional videos are a great way to convey information and attract the interest of potential contributors.
Business owners need to reach as many people as possible to gain a significant enough amount of funding, and social media is a fantastic avenue to do just that. Individuals who support a particular business’s crowdfunding campaign can share a link to their Facebook or Twitter, ideally driving members of their social media network to also contribute to the campaign.
Not only do participants want to know the purpose of the campaign; they also want to know what their reward is for participating. What incentive will they receive in exchange for their money? When will they receive it? Is it worth it to contribute a little more money to get a bigger incentive? A small business must define the incentive that it will offer to contributors and when they can expect to receive it. Some businesses may have the capacity to send rewards immediately; others may need to wait until their business has taken off before they have the means to distribute the promised incentives.
In some cases, incentives are only available with a minimum contribution amount. Other times, the incentives get bigger and better when contributors give more. Business owners can also set a cap for the number of rewards available. For example, the first 400 individuals who contribute $50+ will receive a t-shirt. Anyone who contributes after the 400th person will not receive a t-shirt, and anyone who contributes less than $50 will not receive a t-shirt. A business should consider the cost of distributing rewards to contributors when deciding which structure is best.
What are the perks of using rewards-based crowdfunding?
By utilizing rewards-based crowdfunding, a small business or startup can raise capital to get new ideas up and running. There are a range of advantages for choosing a rewards-based campaign.
First, running a rewards-based crowdfunding campaign comes with little to no cost, making it the most inexpensive form of capital raising. On most platforms, setting up a campaign is completely free, and if the business fails to meet its fundraising goal, the funds are returned to contributors and the business walks away without consequence (except for a failure to raise funds). The business only pays a fee to the platform once it has reached its goal and is ready to use the funds.
Second, a rewards-based crowdfunding campaign is significantly less risky than other forms of fundraising. As discussed above, the company walks away without consequence if the campaign fails to reach the set goal. Bank loans come with interest payments and credit implications, no matter how successful or unsuccessful the business is. Crowdfunding does not require collateral or a credit check like a bank loan does.
Rewards-based crowdfunding is also very trendy at the moment. People like learning about new companies and will contribute to those they find interesting. Contributors can feel personally connected with a business through this type of campaign, and will help spread the word about the campaign. In this way, a crowdfunding campaign can serve as a grassroots avenue of marketing.
What are some drawbacks of using rewards-based crowdfunding?
Like mentioned above, if a business’s crowdfunding campaign does not reach its goal, the company walks away with nothing. The business doesn’t receive any money if it can’t reach its minimum goal.
Reaching that goal is no easy task. Because individual contributions are usually small, a business needs to reach a large number of people–and needs to convince them to contribute. This can be daunting and time consuming. A reward-based crowdfunding campaign may not be the right choice for businesses seeking to raise a large amount of capital.
Another drawback that a business will encounter is paying taxes. The money raised from a crowdfunding campaign is taxable income, so business owners should take that into consideration before setting up a crowdfunding campaign.
For almost 20 years Kim Lowe has lawyered from the trenches. Kim lawyers from experience, using her knowledge of the law and understanding of how both for-profit and nonprofit business enterprises operate.
Emilee Walters is our first Avisen Legal Fellow alum and a third-year law student at St. Thomas School of Law. Emilee is an Avisen Fellow exploring a legal career in business law.