Is Crowdfunding the Next Big Financing Thing?

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.

Is Crowdfunding the Next Big (Financing) Thing?

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?

23 Comments ▼

Rieva Lesonsky


Rieva Lesonsky Rieva Lesonsky is a staff writer for Small Business Trends covering employment, retail trends and women in business. She is CEO of GrowBiz Media, a media company that helps entrepreneurs start and grow their businesses. Follow her on Google+ and visit her blog, SmallBizDaily, to get the scoop on business trends and sign up for Rieva’s free TrendCast reports.

23 Reactions

  1. Hi Rieva,

    Very new concept, I wasn’t familiar with this upcoming trend. Thanks for sharing! Financial stability is so important in a business, especially gathering the initial capital becomes a hassle, but with such sites coming up, it would definitely encourage more entrepreneurs to put their ideas to life. You and your readership may find this article interesting:

    http://businessinsightsblog.trainingforentrepreneurs.com/2010/08/16/making-your-working-capital-work/

  2. Rieva
    I love the crowdfunding phenomena. Love it. I’ve heard mostly good things, however, I’ve only talked to the ventures that got funded. The people who have not received funding are probably less gungho about it. I’m considering giving it a try for a project of mine this year.

  3. Hi Rieva –

    I wouldn’t lump Kickstarter in with sites like Prosper, because on Kickstarter, the money is a GIFT. It’s not a loan to be repaid. Kickstarter also will only work to fund specific products or projects – you can’t use it to pay off debt or for general growth capital. It’s a bit different from the others.

    Most users offer rewards that include copies of their product, so it’s not all profit. But there are no loan payments, which is a terrific advantage.

  4. Rieva, what protections do investors have through these crowd-funding sites? What happens if the company can’t repay it?

  5. Crowd-funding is a new and for entrepreneurs, almost the only way to raise start up funds without going to family and friends who quite frankly in this economy aren’t lending any more money then the banks.

    Kickstarter was aimed at more creative or artistic projects but now has products too and their backers receive rewards for their participation. They don’t own a share of the project or receive dividends. Any level from $1 to $1,000,000 or more.

    Funders aren’t backers in the conventional sense. They are in essence giving a small amount of money in return for something very small from the project. In one case for $25 you would receive a $34.95 product once finished. You were really just pre-ordering.

    Still beats angels at 40%.

  6. The task of securing business investment is notoriously difficult at the best of times; and in today

  7. I believe crowdfunding is a great idea, especially for individuals and small projects. Here is a new spin on crowdfunding – Sponzu.com – where people can fund grassroots initiatives and small ideas by watching a 30 sec video ad.

  8. We have built the first crowdfunding app that people can use (hosted) and one thing our clients have come up against are legal limits on the number of Funders allowed. In Canada (and the US I think) once you have 49 ‘investors’ then you start to get te attention of Securities regulators. You also need to be careful how you promote the Crowdsourcing campaigns. Just fyi’s – the laws need to be updated.

    Paul Dombowsky
    CEO
    Ideavibes

  9. My answer to your question is: Too soon to tell. Crowdfunding has serious potential, especially for social entrepreneurs who can attract the funds of both those interested in an investment and those interested in making the world a better place. However, the technology is just getting refined, the pitfalls just being discovered, the safeguards just put in place. It will be valuable someday, I think, just as collaboration and wikis have but only after some trial and error.

  10. Rieva,

    Have you seen international crow-funding sites and companies?

  11. Hi All,

    Interesting article and one that highlights most of the main issues. There is one perspective that you have not touched upon….i.e. the safety of conventional investing vs investing in start-up businesses.

    With the financial crisis showing just how “risky” safer investments (bank deposits) actually are, if investors can choose to invest small amounts in new ventures directly, with the prospect of better returns (20-27% IRR) and in the knowledge that start-ups are a key driver in creating jobs…..surely this is of benefit to more than just the entreprenuer. It benefits the community which surrounds the venture, employs people in that community and buys real goods and services from the real economy.

    Seedups.com is one such crowdfunding platform bringing investors and entreprenuers together with a view to creating new companies and new jobs. We have launched in the UK and Ireland and launch in the US at SXSW.com Interactive March 2011. We look forward to more debate and welcome any contact from people intereted in the potential and the power of crowdfunding.

    Regards

    Michael Faulkner (Founder / CEO Seedups.com)

  12. here, I did find support for new startups, non-bureaucratic and based on private power, and this is really light for me.
    are in Italy and I have not found this in any hidden corner.
    so far I have tried in Italy, but now my limits have fallen. I thank you for the valuable information in support of my startup to export italian food&beverage in Asia.
    greetings

  13. Hi Rieva,

    I Came across your post searching for crowdfunding articles, very nice. I work for My Major Company which is a crowdfunding record label and thought I’d say a little bit about us. We sign artists and our members raise the investment to record, market and tour their albums with a percentage of the revenue going to the investors. We launched in Oct 2010 and have had 2 UK acts reach the full £100,000 investment so far with the first album to be released in the coming months. Hope you find this info interesting. Keep up the good work.

    Chris

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