CHAPTER ELEVEN: Part B – While crowdfunding may be a soothing alternative to bank loans and equity financing options, it has its own upside and downside. And you shouldn’t plunge into a crowdfunding campaign until you have really weighed the advantages against the disadvantages.

5 Advantages of Raising Funds through Crowdfunding

1. Access to capital

Crowdfunding can provide you with the capital you need to start or expand your business, especially if you are unable to secure a bank loan or convince angel and venture capitalists to support your business. It’s much easier for several individuals to each contribute a small fraction of the funds you need than it is for a bank or angel to risk much huger amounts. This partly explains why crowdfunding usually works.

2. Awareness

Crowdfunding helps you create brand awareness before your business launches. As contributors wait for the launch, they will keep telling their friends. So, while you are perfecting your plans to launch with a bang, word of mouth is working in the background to make your business popular. In short, your investors become automatic ambassadors for your business.

3. Feedback

Whether your campaign is successful or not, you will receive feedback. Realizing your needed funds much earlier than you expected is an indication that people are convinced by your business’s quality and edge. Such a successful campaign tells that you have a big one on your hands.

If your business fails to reach its goal at the end of the crowdfunding campaign, that’s an indication that it needs some tweaking or will most likely fail in the long term. This fate, in itself, is an advantage, as it will help you correct any loopholes before making another attempt.

4. Speed of response

Crowdfunding campaigns tend to be relatively short, compared with the length of time it will take for venture capitalists or banks to scrutinize your business before parting with their money. Most crowdfunding campaigns run for a timescale of one month. In fact, some could be as short as one week!

5. Free press coverage

Your crowdfunding campaign can attract media attention if it’s exceptionally successful or is considered unique in another way. This way, potential customers would have known about your business before its eventual launch. What could be a better means of cheap marketing?

7 Disadvantages of Financing a Business through Crowdfunding

1. The “All-or-Nothing” model

Most crowdfunding platforms use the “All-or-Nothing” model, which means if you are unable to raise your target amount, you get nothing, even if you fall short by the whiskers. The rationale behind this arranagement is that you won’t be able to put the money to good use, since it’s not up to what you need.

So, rather than allow you “squander” contributors’ money, the platform will return their money back to them. Failing to meet your target on a crowdfunding platform that adopts the “All-or-Nothing” models means you have only wasted all the time and money invested in the crowdfunding campaign.

2. Reputation

If your crowdfunding campaign flops, the details will remain on the crowdfunding platform for all to see. And you never know who might get to see it. The page may even show up when someone tries to search the web for your business.

3. Pressure

It’s a good thing that contributors will quickly invest in your business once they are convinced that it will thrive. But these contributors, just as they pledged their support for your business in a timely manner, usually expect you to launching your business in a timely manner, too. So, your business needs to launch within months of the end of the campaign, and this may mount lots of undue pressure on you.

4. Hidden costs

It often happens that creators will add in extra rewards during their crowdfunding campaigns (to encourage more investors), without factoring in the extra costs that those rewards will actually involve. Similarly, some creators offer rewards that may cost more than planned.

A good example is a creator planning to start a watch manufacturing business and crowdfunding with the aim of rewarding each contributor with a wristwatch once the business launches. One likely mistake of such a creator is to forget that each contributor will have to receive their watch by mail, which means additional costs of shipment.

5. Negative impact on other financing options

Crowdfunded businesses are usually indebted (debt-wise or equity-wise) to large numbers of investors, each with tiny stakes in the business. This structure could deter venture capitalists or angel investors when you approach them for funding in the future, as many of them are leery of investing in a firm owned by hundreds to thousands of inexperienced shareholders.

6. Limitations

If you raise $1million or more through equity crowdfunding, you cannot seek additional funds for the next one year. Otherwise, your business must comply with certain securities registration requirements. So, what happens if your business undergoes rapid growth and needs more money within that period to expand?

7. Potential lawsuits

Investors usually expect quick returns and may not be patient if your business does not generate profits as expected. Lawsuits arising from failed business ventures can therefore occur. You may also be accused of fraud, breach of contract, or mismanagement.

Since each investor contributes very small amounts, it may be cost prohibitive for them to pursue legal claims. However, they can file complaints to regulatory agencies that might lead to investigations. You sure don’t want that headache.