16 October 2022
Understanding Crowdfunding As A Business Financing Option
Early-stage businesses often struggle to secure cost-effective funding and sometimes it may be tempting to look to alternative solutions, such as crowdfunding. It can serve different purposes all at the same time: raising capital, marketing, engaging consumers, product trials and publicity, making it an attractive option.
While crowdfunding may not follow the traditional financing route, it is still a regulated activity and requires sound knowledge of the rules and risks involved.
What Is Crowdfunding?
Crowdfunding is a route open to businesses to raise money from the public. It is usually for a specific project, product or purpose, and the project is pitched to the public through specific crowdfunding websites like Seedrs or Kickstarter.
The fundraising campaign must be carefully planned, marketed and executed for it to be successful. There is inevitably a cost associated with putting the campaign together, including a video, pitch deck and marketing costs. Typically, such costs would start at around £5,000.
Types Of Crowdfunding
There are four main types of crowdfunding:
- Donation based crowdfunding, which allows supporters and members of the public to donate money to the business.
- Pre-payment based crowdfunding, which relies on consumers lending money in return for some tangible rewards. Examples of rewards may include gift vouchers or sample products from the business.
- Loan based crowdfunding, where consumers will lend money to the business in return for interest payments and repayment of capital over time.
- Investment based crowdfunding, where members of the public will invest in the business through the issuance of shares or other instruments that are similar to bonds.
Careful consideration ought to be given to which type of crowdfunding is most suitable for your purpose, weighing up the costs, benefits, and time you will need to invest.
Advantages Of Crowdfunding
Crowdfunding can offer several advantages, namely:
- Target audience engagement. Arguably, pitching to and persuading potential consumers to invest in your business should be easier than seeking other sources of funding like a bank loan. If consumers get onboard with your brand at a critical juncture in your business, a successful crowdfunding campaign could serve a dual purpose of getting funding while increasing customer following and consequential conversion of sales in the future.
- Interest and repayment free investment. If you choose a payment or service-based campaign, you will get funding from the public investors without any obligation to pay back their contributions. If you offer rewards, of course those must be honoured but crowdfunding can clearly offer a cheaper route to funding cashflow.
- Market testing. If the public invest in your campaign and in return receive free samples or discounted products, your funding creates a route for market testing and feedback at the same time.
- Knowledge bank. Crowdfunding has become quite mainstream so that you can draw on the expertise of consultants who know the tricks and tips to making a campaign successful and professionals like us who can help you navigate the legalities of the process too.
Disadvantages Of Using Crowdfunding
There are several disadvantages that you should consider and your solicitor will highlight the risks for your particular business. Some of the main ones include:
- Campaign costs and fees. At the basic level, you must factor in the cost of creating your campaign content and marketing costs to help get the word out. In addition, the platform you use for crowdfunding will charge a fee – usually a percentage of the total funds raised. If the campaign involves you sending out free rewards to investors, the cost of sourcing, manufacturing and distributing the goods needs to be factored into your campaign planning. For example, if you ended up getting 10,000 investors and you need to send one or more products to each investor, the production cost and postage cost could be substantial.
- Business reputation. The accountability a business has to take on with respect to crowdfunding does not stop with creating a convincing pitch. You will be held accountable publicly for fulfilling any obligations you have to the consumers. If the crowdfunding is loan based or investment based, the ongoing performance and success of your business will be public, and this will have an impact on the reputation of your business and future success.
- The odds of a successful campaign. It is thought that close to 60 per cent of crowdfunding campaigns fail. Should your campaign not succeed, you will need to absorb the campaign costs incurred and possibly spend more time and money sourcing other options for funding.
- Risk to future investment. With the campaigns being on the internet and their history being available in the public domain, it is possible that an unsuccessful attempt at crowdfunding could negatively impact any future attempts at fundraising, or even cause concern for any direct investors considering your business.
Legal Issues To Consider
The rules and legalities you will need to follow will depend upon the type of crowdfunding you pursue. The investment and peer-to-peer lending campaigns are regulated by the Financial Conduct Authority (FCA) and their rules and requirements need to be adhered to.
The UK Crowdfunding Association (UKCFA), which was set up as a self-regulatory trade body with its own code of conduct, also recommends steps that need to be taken to protect the investors.
You are likely to need to seek legal advice on:
- contracts, including any you enter with crowdfunding consultants;
- how (if at all) the Payment Service Regulations 2017 may apply;
- intellectual property rights; and
- data processing protocols and compliance.
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