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What is crowdfunding?

How does crowdfunding work and is it right for your business?

With the economic downturn causing banks to tighten their purse strings, you may need to find alternative sources of funding to get your start-up off the ground. Indeed, 65% of entrepreneurs planned to seek alternative finance in 2012, according to a survey by Huddlebuy.

With this in mind, in December 2011 MP Vince Cable launched a taskforce to open fresh funding channels for small UK businesses – putting particular emphasis on the opportunities of crowdfunding.

What is crowdfunding and how does it work?

Crowdfunding is an alternative method of raising finance for a business, project or idea, popularised by Kickstarter.com in the United States.

Unlike angel investment, in which one person typically takes a larger stake in a small business, with crowdfunding an entrepreneur can attract a ‘crowd’ of people – each of whom takes a small stake in a business idea, by contributing towards an online funding target.

It is believed that, in many cases, this model is more successful than attempting to source the full investment required from a single individual or organisation. Furthermore, while some investors may be hesitant to invest in an unproven idea, crowdfunding provides an alternative way to source seed capital from a number of backers.

How much does it cost?

The majority of crowdfunding platforms won’t charge you for publishing a pitch, however they typically take around 5% commission when you reach your target – so you need to factor this into your investment total. If you don’t meet your target, you don’t pay a penny.

To encourage people to invest in your start-up, most websites ask you to offer staggered rewards (such as exclusive access to your first product or a five-year discount on your services) according to how much people invest.

However, there are also a couple of platforms, such as Startups’ own crowdfunding site, powered by Crowdcube, which allow you to offer a small proportion of equity in your business, to create an added incentive for potential investors. This is particularly appropriate for start-ups looking to raise larger sums of finance.

How could crowdfunding benefit my business?

The main benefit of crowdfunding is that it creates a strong network of support for your start-up. With the equity model in particular, your investors are likely to become ambassadors for your brand – promoting it among their networks, tracking your progress and becoming returning customers themselves. They may also offer to lend a hand, for example by providing free legal advice or accountancy services.

If you promote your investment bid successfully, crowdfunding can also provide a powerful platform to raise awareness of your start-up. It gives you a newsworthy story to pitch to your local, and national, press (which may attract further new business). If you reach your target it also gives a clear message to potential clients, suppliers or future investors that you have the support of the public behind you.

Furthermore, crowdfunding can provide a very fast way to raise cash – several start-ups have reached their target in just a few days – and there are normally no upfront fees, keeping the process simple. Most crowdfunding platforms will look after much of the legal administration for you as well.

Crowdfunding also provides a simple and secure way for your friends and family to support your idea and, under the government’s Enterprise Investment Scheme, anyone investing between £500 and £1m in a qualifying business will have the added incentive of becoming eligible for income tax relief, worth 30% of the amount invested.

From 6 April 2012, investors pledging between £500 and £100,000 in a qualifying start-up will benefit from 50% relief, under the Seed Enterprise Investment Scheme, which was announced by the coalition in the 2011 Autumn Statement.

Is crowdfunding right for my start-up?

Crowdfunding works best for start-ups that have a story to tell – whether a personal reason for starting the business, a passionate vision for what it could become, or a social mission.

People have to feel inspired to invest so you need to write a charismatic pitch to get potential investors’ pulses racing, or else display evidence of outstanding innovation.

If you have a mundane or complicated concept which the public will struggle to connect to, crowdfunding may not be right for your start-up. However, any business can succeed with the right pitch – the key to crowdfunding success is: keep it simple.

What if someone copies my idea?

There is always a risk of copyright infringement when you release your concept into a public domain, such as the internet, before you launch. However, the chance of someone copying your idea shouldn’t be any higher through crowdfunding than in the period between launching and your business becoming well-known.

Also, because of the scope for crowdfunding to raise awareness of your business, if your idea is original it may actually gain a reputation as the first of its kind – deterring copy-cats.

It is important to remember that the nature of a crowd is, not everybody will agree. Some people may think that your idea is flawed, which may further safeguard it from imitation.

What happens when I reach my crowdfunding target?

As with most business deals, when your online target is reached there will be a short ‘cooling-off’ period. Investors will be asked to confirm their investment and those who can’t follow through may be given the option to withdraw their pledge.

The crowdfunding platform will then refer the case to their lawyers, who will formalise the deal and the money will be transferred to your bank account.

You will be given the details of your investors, so you can liaise with them directly and begin processing their rewards. If you are offering equity, investors may be sent a certificate detailing their shareholding.

How involved will investors be in my business?

If you are using a reward-based platform your commitment to your investors officially ends when their rewards are delivered. However, the more involved you keep them in your start-up, the more they will support and endorse your business as it progresses.

You may wish to create a mailing list to send them newsletters or seasonal discounts to maintain their interest. The same principle applies if you crowdfund through an equity-based model, although you may also want to include evidence that you are delivering on forecasted growth and meeting financial targets.

In the latter case, you do have some level of responsibility to your investors, however you shouldn’t be concerned about interference with the day-to-day running of your start-up. Depending on how much equity you released, generally each investor will only hold a point of a percentage stake in your business.

What are the best tips for crowdfunding success?

Key to successful crowdfunding is understanding the commitment the process entails. Crowdfunding can provide a fantastic opportunity for small businesses, but it should not be entered into lightly and, to be successful, requires a careful strategy.

Make sure you have the resource in place to promote your pitch daily, as well as take every phone call and answer every email from potential investors. You need to create and maintain momentum to meet your target.

Prior planning is crucial – how are you going to create a buzz around your business? Find out who your potential customers are and court them for several months before launching your pitch, finding out what kinds of rewards would entice them to invest. That way, when you launch the crowdfunding, people will be excited and you can get your business off to the best start.

If you’re interested in raising finance using crowdfunding take a look at our crowdfunding platform. We’ve partnered with Crowdcube to offer businesses a new way to raise seed or growth capital.

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