Financing Start-ups Through Crowdfunding

Digitisation is affecting everything in modern business. From how companies market themselves to their intended user, to how people apply for jobs. Start-ups are no different and have been forced to adapt to the same changes as all other companies in all industries.

One area that has changed dramatically is financing. Before digitisation, the standard process to obtain funding for a start-up was to go to a bank with an extensive business plan. After going through every tiny detail of how you intend to make enough money to make the business work in order to pay the loan back, the bank would then decide whether to approve your application or not. If approved, you would receive the money in around 12 weeks.

Although traditional bank loans are still available, a viable option for both start-ups and established businesses is crowdfunding – an idea that was developed after the economic crises as companies discovered it was becoming more difficult to be approved for bank loans.

Crowdfunding is the way in which a company or organisation can finance a business or project by asking a large amount of people for small sums of money, generally in return for an award. The award can be anything from equity in the company to a simple thank you.  model

There are four main reward systems that can be applied:

  • Equity – Selling shares of the business
  • Reward – This can be anything from the first product produced by a company, to an event in your honour
  • Loan – This is possibly the best option as a business can keep its equity share. However, interest rates are high, in the region of 8%
  • Donation – This can be utilised if a charity is crowdfunding, or a business is raising funds based an idea that they believe people will support for the sake of the idea.

By signing up to a platform like Kickstarter or Indiegogo, a company can present their kickstarterproduct to the public with a pitch, usually in the form of a video outlining the functionality of the product or service. If, say for example a company hopes to raise £10,000, they will not receive any money until they raise the entire £10,000 within the period of the campaign which is usually one to two months.

Of course, there are pros and cons to crowdfunding. From the perspective of the public, what you see is a piece of marketing and it may hide some of the realities. For example, unlike with a bank loan, the company determines the company value, not the bank. This can lead to an over estimation of their value, which does not give a true reflection for their potential for growth, or lack thereof. For this reason, it is wise when investing to spread your investments over multiple projects. This will limit the potential loss incurred by the failure of a business.

There are also drawbacks for businesses. If a company sells equity of their business, unless stated otherwise, they are giving voting rights and a say to people who may not be experienced or knowledgeable in the business. This can lead to difficulties with product development or any changes within the business.

One major advantage however, is the speed in which a business can get the money. If a campaign has been successful, the money is made available within a couple of days – very different from the banks three-month average. A bank will also require the business to have collateral and a good credit score, which is not an necessity with crowdfunding.

Overall, crowdfunding offers an alternative to banks for funding your business or project, in particular start-ups, which are a much riskier endeavour in comparison to an established business. It also presents the general public with an opportunity to invest in new businesses and lend money with a high return of interest.

Whether crowdfunding is the answer for every business is doubtful, but it is another example of digitisation disrupting the old model and inspiring innovation within an industry.

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One thought on “Financing Start-ups Through Crowdfunding

  1. Pingback: The Reader’s Digest – A pick of January blog posts | Design Thinking for Start-ups

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