Crowdfunding has become an increasingly popular way for startups to raise capital quickly and easily in an increasingly challenging fundraising environment. It provides startup founders access to alternative fundraising methods and potential investors who may not have otherwise been available, allowing them to pursue the funding they need to launch and grow their businesses.
With the right strategy and preparation, crowdfunding can be a successful and effective way for early-stage startups to secure financing. While crowdfunding allows startups to seek funding outside of angel investors and venture capital (VC) firms, the limitations and challenges it presents must be considered before jumping in.
Why the fundraising environment is driving startups to alternative capital sources
Some startup founders have struggled to raise capital for Series A rounds and later funding stages due to a variety of factors. During the COVID-19 pandemic, a surge of new businesses launched, with a peak in 2020 that was nearly matched by the number of new startups in 2021. This has increased competition among startups for the same funds.
Venture capital firms have also become increasingly absent from dealmaking in 2023, according to PitchBook, which reports that the number of active investors in U.S. venture capital has declined by 38% in the first three quarters of 2023 as compared to the same period the year before.
Diversifying funding options can help startups overcome this roadblock. While incubators, accelerators and government grants are excellent options for founders looking to extend their runway, these may be options you've already tried or ruled out. Crowdfunding is a way to get the resources your startup needs to meet its growth or production goals.
Knowing which platform, the type of crowdfunding and the rules involved can help early-stage startups overcome the challenges and find the funding they need.
Four types of crowdfunding
There are dozens, if not hundreds, of crowdfunding platforms to choose from. Each uses one of four types of crowdfunding that comes with its own benefits and disadvantages. Choosing the appropriate type of crowdfunding depends on a startup's specific needs, goals and capacity to offer rewards, equity or repayment.
Consider your choices carefully before launching a crowdfunding campaign, as some platforms only support "all-or-nothing" campaigns. On those websites, which include the popular crowdfunding platform Kickstarter, you are only permitted to keep the funds you raised if you meet your fundraising goal. Others are more lenient, allowing startups to keep what they've raised even if it falls short of their target. Research platforms before choosing to determine their type and your company's ability to follow the site's guidelines.
1. Donation-based crowdfunding
GoFundMe is a popular crowdfunding choice used by a wide variety of individuals and businesses to meet fundraising goals. Like other donation-based crowdfunding, users donate without expecting financial returns or a reward. Startups with a charitable or social focus often turn to this method of fundraising to fund initiatives that benefit the community or address a specific issue.
Because it's donation-based, donors won't receive any tangible benefit outside of a sense of generosity for their contribution. Since many other individuals and charities also use this form of crowdfunding, it can be challenging for startups to attract enough attention and donations to their own campaigns to meet their funding goals.
2. Debt-based crowdfunding
Also known as peer-to-peer lending, debt-based crowdfunding involves startups borrowing money from individuals or groups and promising to repay the borrowed amount. This typically includes interest and must be paid back over a fixed period, much like a traditional loan. Selecting this type allows startup founders access to needed capital while maintaining ownership and business control.
As with any other loan, peer-to-peer lending adds the financial obligation to pay back the funds with interest, but it may be a faster way to increase capital than it would take to get a business loan from a bank. Keep in mind that lenders may ask for collateral or personal guarantees, which can increase the risk for founders.
3. Equity-based crowdfunding
Equity-based crowdfunding allows startups to raise funds by selling shares or ownership stakes in their company to individual investors. In this model, investors receive a financial return on their investment in the form of dividends or a share of the company's profits. Founders using this crowdfunding method can attract higher dollar contributions than other methods that rely on more donations in smaller dollar amounts. However, startups are required to give up a portion of their ownership and control to investors. They must also remain in compliance with securities regulations, which can be complex and costly.
4. Rewards-based crowdfunding
Patreon and Kickstarter are excellent examples of rewards-based crowdfunding. A user pays a creator a set amount; in return, the user receives something as an incentive for their contribution. This could be access to downloadable content or something tangible like a piece of art or clothing. Rewards-based crowdfunding can help create a sense of community and engage supporters. Startups will need to carefully plan out and fulfill their promised rewards, which can be time-consuming and costly.
3 tips for crowdfunding startup companies
Raising funds from potential investors in venture capital differs greatly from crowdfunding. The same tactics that work well with a panel of investors, such as details about your business model, competitor information and financial projections, won't translate well to a different audience of potential donors. The following tips can help you achieve a successful crowdfunding campaign.
1. Learn your audience's habits
Even before selecting the type of fundraising campaign or platform your startup will use, determine who your audience is and learn about their habits. For instance, an indie video game developer may find their target market is more likely to donate to campaigns on Kickstarter than GoFundMe because they enjoy the perks they get for their contributions. A fledgling art retailer might find more success with a Patreon page rather than a Kickstarter account. Avoid trying to mold the platform or audience to your needs.
2. Tell your story and tell it well
To get eyes and ears on your campaign, it's vital to share your story. Humans have always responded positively to storytelling. Use that to your advantage. Let your audience know what your product is — how it can impact their lives — and share the impact it's already had on your life. Storytelling can help generate a strong emotional reaction, so try to attach that reaction to your product or service.
3. Be realistic about your goals and timetable
Don't expect your crowdfunding efforts to be an overnight success that generates millions of dollars for your startup. While some Kickstarter campaigns have gone viral, resulting in millions of dollars’ worth of donations and contributions, don't necessarily expect this to be the case for you. Only 0.3% of successful campaigns raised $1 million or more on the platform, with most successful campaigns raising $1,000 to $9,999. Give yourself enough time to develop a crowdfunding strategy that complements your startup and your business plan.
Crowdfunding can be a useful tactic for extending your runway at a time when venture capitalist funds are harder to come by. This strategy requires a completely different mindset from pitching to VC firms and investors, so it's important to research your chosen platform in depth before starting a campaign. A financial advisor or CPA can help you determine whether this is the right choice for your business and help devise a plan to maximize your contributions.
Need guidance on next steps with your startup? Anders CPAs + Advisors works with startups and entrepreneurs on their financial needs so they can focus on what they do best. Contact an Anders advisor to discuss your goals and how we can help you achieve them.
Every day at Anders, we serve as a catalyst for those striving to achieve their highest potential and carry this mentality on to our clients and community. Through a collaborative approach and a combination of tax, audit and advisory services, we help our clients achieve their goals.
Max Goewert, CPA, works with individuals and businesses on tax and financial planning opportunities. Goewert endeavors to help clients, particularly startup companies, minimize their tax and compliance burdens to achieve growth and meet their business goals.
