Over the past few years, as the credit crunch tightened, we’ve all heard horror stories from successful entrepreneurs who had growing businesses but couldn’t get working capital, or saw their business lines of credit cut or their loans called in for no reason. No wonder many small business owners have become leery of traditional financing sources.
For small business owners seeking capital in a tough economy, will crowdfunding prove to be the next big thing?
Crowdfunding has some similarities to the peer-to-peer lending sites, such as Prosper.com, that arose several years ago, but some important differences as well. Both types of sites allow individuals to solicit financing from others for any purpose. But while peer-to-peer lending typically focuses on one individual lending to another, crowdfunding—as its name implies—aims to reach a funding goal by getting many investors to put in small amounts.
The Wall Street Journal recently took a look at the crowdfunding phenomenon, and talked to some experts who believe it’s about to take off. Using sites such as ProFounder.com, Peerbackers.com, Kickstarter.com and IndieGoGo.com, entrepreneurs can set up a profile that explains how much money they’re seeking and what it will be used for. Investors pledge money toward the goal. The sites make their money by taking a percentage of the investment.
A crowdfunding site can be a great way to simplify the process of seeking financing from, say, family and friends. And until now, most business owners using the sites have been looking for very small amounts ($10,000 or less). However, according to the Journal, the sites are beginning to enable larger transactions as more business owners are turning to them.
Crowdfunding sites have their pros and cons. Like any other business tool, before you consider using one, you need to consider whether it’s a fit for your target audience. If your business’s target customer is younger and more tech-savvy—comfortable with the idea of “crowd”-anything—raising money from people who fit your target customer profile and can understand the profit potential of your business will be easier. On the other hand, if you’re trying to raise capital to start or grow a business in a more conservative industry, or if you’re pitching your elderly relatives to invest in your business, the crowdfunding concept is less likely to fly.
Crowdfunding sites differ in how they operate, but many do not release any funds unless the company’s target amount is met. At RocketHub, about 25 percent of small businesses hit their targets; at IndieGoGo only about 10 percent of projects do. Also keep in mind that, although sites do a preliminary background check of businesses seeking financing, they don’t take responsibility for the outcome or ensure that businesses deliver what they promise. This may make crowdfunding risky business for potential investors who are truly part of the “crowd” and don’t have some connection to you.
Have you used crowdfunding? What do you think of its potential for powering business in the coming years?