When people refer to crowdfunding, they generally mean raising money in return for a small amount of stock or ownership in the new company. However, there are actually two types of crowdfunding.
1. Equity crowdfunding
Equity crowdfunding enables large numbers of people to invest small amounts of money in new ventures in return for a small piece of ownership, or shares, or equity.
In 2012, the United States Congress passed the Jumpstart Our Business Startups (JOBS) Act, making it possible for entrepreneurs to raise funds from a large number of small investors. The U.S. Security and Exchange Commission (SEC), wanting to protect investors from fraud and to keep ill-equipped investors from losing significant sums in risky ventures, developed a large set of rules to govern this type of crowdfunding (also referred to as “Regulation Crowdfunding” in the U.S.), and these regulations continue to evolve as the investment community gets more experience with equity crowdfunding.
2. Non-equity or “rewards-based” crowdfunding
Before the rules were enacted to enable equity crowdfunding, startups realized they could raise a lot of money and gain a lot of support by providing prerelease products, rewards, or benefits to those who believed in, and wanted to support, their vision.
Through online crowdfunding platforms, and by driving support through social media and other activities, entrepreneurs could make early sales of their prerelease products to fund their new ventures. In return for a certain “donation,” supporters would receive products once they finally became available. In essence, these prerelease customers—instead of professional investors—crowdfunded the new business.
Keys to success in crowdfunding
As with other forms of funding, you’ll have to be prepared—and do your homework. As crowdfunding investors get more sophisticated, they’ll want more than just a great video to motivate them to part with their money. They’ll want to see that you have a team that can execute, a reasonable business plan, and that they have a good chance of making their money back—or that at least you’ll use the money as intended. Simply because the amounts of cash exchanging hands are smaller doesn’t mean you won’t face some of the same scrutiny you would from established investors.
1. Have the right type of business or product. For crowdfunding success, your idea must be easily understandable by a large number of people (on that platform). Consumer, food, consumer electronics, and fashion products are particularly well suited to this. Complex concepts and many business-to-business ventures are likely to have a harder time gathering widespread support.
2. Create a compelling video. A great video helps engage potential funders, as most funders will want to hear your story, see you, and view prototypes of your product (if any).
3. Raise sufficient funds. On some crowdfunding platforms, you don’t receive any money until your goal amount is raised in total. This means you want to set an achievable fund-raising target. However, on some platforms, you can raise no more than the financial target you originally set. So you want to make sure you are raising enough to execute on your vision. This can be very hard to get right—even for seasoned entrepreneurs.
4. Choose the right crowdfunding platform. Make sure the platform you choose meets your particular needs—type of product or service, type of rewards or equity you can give, amount of money you can raise and whether you need to raise the full amount before receiving any of it.
5. Have good-quality photos as part of your campaign. Pics help supporters spread the word through social media.
6. Have a “coolness” factor. Your idea is more likely to garner support and go viral if it’s unique, attractive, or cutting-edge.
7. Plan a marketing campaign. You must plan your crowdfunding fundraising campaign like you would for launching any new product. It will take time, effort, and creativity.
To help you plan and execute a successful crowdfunding campaign, download the worksheet “My Crowdfunding Plan.”
Excerpted from Six-Week Startup 4th Edition, now available. Look inside the book here.