Raising capital for a business is usually seen as one of the most difficult aspect of bringing a business idea to fruition, but new technologies and platforms have given entrepreneurs a plethora of ways to make that happen.
Traditionally, small business owners have relied on family and friends for seed capital to launch their business. If all goes according to plan, one might bring in equity partners to help fund further growth, or apply for a bank loan to expand operations.
Now, there is another alternative - attracting small volume of investments by a large quantity through a process call crowdfunding. Essentially, this involves the use of a technological platform to gather investors who are interested in funding your idea. As a business owner, you pay a processing fee to the platform for this service.
In fact, if your idea hits the right buttons with your target market, you might be able to get the full funding amount in a matter of days at no financing costs to you.
Beyond the hype, is there a downside to crowdfunding? Is tradtional financing being made obsolete then?
Pros And Cons Of Crowdfunding
One of the best reasons for considering crowdfunding as a financing source is the ease of launching a fund-raising campaign. All the major platforms will guide you through a step-by-step process as you pitch your ideas online. Because the individual investment amounts are small, there's little need to prepare a detailed business plan with a 5-year forecast.
Compared to asking for a business loan where you'd need to prepare all your documents and paperwork on top of the long lead time to get your funds, crowdfunding is considered a breeze.
When engaging venture capital, one of the main concerns of business owners is that they may lose control of their business direction. With crowdfunding, there's no such fear as you do not give up any share of ownership. Investors are usually repaid with the new product(rewards-based) or get a share of the profits(equity-based) from the successful campaign.
Compared to traditional financing methods, crowdfunding is considered much cheaper as well – there's usually no interest to be paid. Using financing methods come at a cost, and may not be the best option for start-ups which have not turned profitable.
Despite all the advantages, there are considerable number of downside to crowdfunding as well.
For one, there is no guarantee that crowdfunding will generate the necessary funds you need. Especially for new ideas, many investors prefer to participate in “all or nothing” campaigns where their funds are held by funding platform until the full target is reached. Funds are returned if the amount falls short, which means the business has to start over or look at other options.
While traditional financing has stricter criteria for businesses to qualify, once you get your approval, your funds are safely in your hands.
With crowdfunding, your idea and pitch needs to be distinctive enough to stand out in the crowded marketplace. Comparatively, there's no such criteria for a bank loan. This means that if you are thinking of expanding existing operations or getting capital to start a new cafe, crowdfunding isn't exactly the best way to do it.
When you have a new innovative business idea, most entrepreneurs guard it to ensure that the idea is not used by someone else who will become the first-comer in the market. In the crowdfunding world, you'd need to disclose the details of your business idea and plan, leaving you vulnerable to prospective competitors who may beat you to the execution of your ideas.
This can be a significant disadvantage, as it would mean many months or years of conceptualising an idea going down the drain.
With bank loans or alternative financiers, these business details are considered confidential. And as long as you are able to prove yourself credit-worthy, provide collaterals or provide proof or future receivables, you will most likely be able to receive extended financing when needed.
Being crowdfunded also puts you in the public eye – should you not be able to deliver the final product by the stipulated deadline, you are likely to receive negative press, hindering you from future financing or funding methods as the public lose faith in the company.
Can Crowdfunding Work For Established Businesses?
Looking at the lists of pros and cons for crowdfunding, it does look like there's little room for more established businesses to take up the crowdfunding route. While bank loans will require some form of credit record or minimum turn-over, there are alternative financiers that small businesses can seek out.
More specifically, companies which are profitable but has a tight cashflow can consider selling accounts receivable, a financing technique known as invoice-factoring. This provides a cheaper alternative to taking up a bank loan and with these invoices as “collaterals”, financiers may be able to disburse the funds needed at a faster speed.
Another way established businesses can raise capital or funds can be through peer-to-peer lending. The concept is rather similar to crowdfunding, except that companies will need to pay the small investors a small interest rate as financing payments.
Despite all the advantages and disadvantages of various financing methods, it is important for business owners to evaluate their financial position and explore every available option. It is important to look at raising funding as an overall business strategy rather than a short-term solution to finding adequate money to sustain the business operations.