(Originally posted on The NIIC blog April 27, 2020)
This is (Karl R. LaPan’s) third installment in his ongoing conversation with Kathleen Minogue. Over the past three weeks, they have been diving deeper into crowdfunding, and how it can be an important catalyst in your capital stack strategy and in your business strategy. He thanked Kathleen for her insights and her willingness to invest in the entrepreneurial education process. There is an incredible upside in crowdfunding given only 2% of small businesses are using it.
Karl: In his early research on crowdfunding, Professor Ethan Mollick of Wharton University observed that the unique value of crowdfunding is not just money, but community and validation for demand. Does this mean crowdfunding might be a good fit for an entrepreneur’s customer discovery and validation field work?
Kathleen: When people think of crowdfunding, they generally think “money” but when I think of crowdfunding I think about “assets.” Sometimes the non-financial assets that a business can glean from a crowdfunding campaign are MORE valuable than the funds. Crowdfunding can provide non-financial assets such as:
- proof of concept
- marketing validation
- brand awareness
- customer acquisition
- customer feedback
- marketing and PR
For example, you are an idea-stage entrepreneur with a working prototype. Wouldn’t it be great if you could know there is an audience for your product, get feedback on the features of your prototype, find potential customers, and acquire the funding you need all BEFORE investing in manufacturing it? Crowdfunding can give you that. Even campaigns that don’t reach their goals are valuable because you may learn that you need to adjust your marketing to reach your target audience or that there isn’t an audience for your idea – all before you’ve invested large amounts of capital in manufacturing your product.
Karl: How did crowdfunding benefit from the passage of The Jumpstart Our Business Startups Act, or JOBS Act, and why is that important for an entrepreneur who is looking for access to investment capital sources?
Kathleen: Prior to the passage of the JOBS Act in 2012, private companies could not use “general solicitation” (advertising) to tell the everyday person on the street that they were looking for investors without complicated and often prohibitively expensive legal filings. Most entrepreneurs were limited to raising capital from “accredited investors” – individuals with a net worth over $1M (often called angel investors or venture capitalists). If you did not know any of these “accredited investors” (who represent less than 5% of the U.S. population) or if your company was not attractive to angel investors or VCs, your chances of raising investment capital were limited.
The JOBS Act created several “exemptions” (exceptions) to these rules, including Regulation Crowdfunding and Regulation A+, that allow private companies to crowdfund investment capital from everyday investors like you and me. Now private companies can not only use crowdfunding to pre-sell products and services, but they can also use crowdfunding for an equity or debt offering to raise investment capital from their community, their customers, and the general public.
Karl: What kinds of costs should I expect when preparing to launch a crowdfunding campaign? Will it cost me money to crowdfund?
Kathleen: Crowdfunding isn’t free money – it costs time and money. Most platforms charge fees for the use of their software, so you’ll want to budget into your goal the funds to cover platform fees and still have enough to deliver on what you have promised. Beyond platform fees, the main crowdfunding expense is marketing.
If you want to lower the cost of your campaign preparation and execution, then you’ll have to be willing to invest more of your time (or find others who are willing to support your success with their time and skills) rather than hiring others to do that work for you. Costs also vary based on:
- the type of crowdfunding
Donation and rewards campaign costs are primarily related to marketing. In addition to marketing costs, investment crowdfunding campaigns have upfront legal and financial compliance costs related to offering securities.
2. your funding goal
Statistically, campaigns with goals of $10k or less are the most successful and the least costly because they are mostly funded from your immediate or first degree network (i.e. friends and family). The more your goal increases above $10k, the more time and money you will need to invest in marketing efforts to reach potential supporters outside your immediate network.
3. the strength of your “known” or existing network
The strength of your network is not only the number of people you can reach but the quality of your relationships with them. For example, if you have a large email list and you’ve nurtured your relationship with these contacts over time, you’ll need to do less to inspire them to support your campaign. If you haven’t communicated with friends or customers and your email list is cold, you’ll have to invest more time and/or money in your marketing efforts to inspire them to support you.
Karl: Where does crowdfunding fit in the capital stack of a business?
Kathleen: I’ve seen companies at all stages of their life-cycle use crowdfunding to support their capital needs. In fact, one of my favorite things to do as a consultant is to help clients see all their crowdfunding possibilities.
Here are a few examples:
- idea-stage entrepreneurs can use crowdfunding to market test their ideas and to raise their very first funding
- start-up companies can raise private capital initially and then use rewards crowdfunding to launch their first product or service
- growing businesses can use rewards crowdfunding to market test a new product or service, or use Regulation Crowdfunding to raise up to $1.07M from investors to finance a business expansion
- established businesses can raise significant equity capital using the Regulation A+ investment crowdfunding exemption that allows capital raises up to $50M
One of my favorite uses of crowdfunding is what I call stepping-stone crowdfunding – where businesses use crowdfunding as leverage to unlock traditional funding (such as bank lending or venture capital) or use several crowdfunding campaigns in a row to finance each milestone of their business. One of my clients used rewards crowdfunding to raise their first capital, then raised private investment capital, then leveraged their crowdfunding and private investment dollars to qualify for a loan from a non-profit lender, and now, after being in business for three years, are using investment crowdfunding to grow their business.
This week’s worthwhile blog we want to highlight as an additional resource is: “Why Small Business Should Be Crowdfunding“.
Also, Crowdfund Better has compiled a list of platforms with COVID19 Relief Initiatives in the various categories of donation, rewards, lending, and investment. This is a useful guide for business builders exploring crowdfunding campaigns.
Editor’s Note: Crowdfund Better is actively working to solve the issues around crowdfunding education for all. We’ve developed The Crowdfunding Opportunity online course to help you navigate the crowdfunding ecosystem to fund your business.