Crowd Funding a Startup (Funding Technology Startups Part 3)

Want to see your (business) name in lights? Today we look at the newest kid on the business funding block – Crowd Funding (alternatively Crowdfunding).

[Note: This is the third article in a series on funding technology startups. Part 1, which provides an overview and delves into the details of self funding and grants is here. Part 2, which focuses on debt and briefly on friends and family funding is here.]

Crowd Funding: New and Powerful

I’ll wager that if you’re a new tech entrepreneur, you’ve at least thought about crowd funding and whether it might be right for your business. I say that with confidence based on the number of clients, or prospective clients, who have approached me with stars in their eyes, saying that they’ve found the answer – crowd funding!

Crowd funding is collecting small amounts of money from a large amount of people – in amounts that can range as low as $5 each to usually no more than a few thousand dollars. Whereas all other business funding involves the development of close relationships with a few people (and along the way usually many other meetings and relationships that do not pan out), crowd funding is based primarily on social proof and viral marketing. The “wisdom of crowds” draws people to the most successful ideas.  Crowdfunding is where social media meets investing.

Every Entrepreneur Should Understand Crowd Funding

This one deserves lots of attention, so pay attention! :-) Crowd funding has amazing potential to disrupt (in a good way!) the funding world. Finding a way to get money out of the hands of those who want to support entrepreneurs and artists and into the hands of those same entrepreneurs and artists is surely a great thing. Crowd funding breaks the rules – and I like things that break the rules.

Before you dive in and decide that crowd funding is how you’re going to do it, however, take a deep breath, and learn about how it works, what it takes to succeed with it, and what your options are should you decide to proceed.

Donation/Rewards, Equity, or Debt?

Most people paying any attention at all know about the donation/rewards model of crowd funding. But there are two other flavors lurking in the wings – equity- and debt-based crowd funding. These are less well known because they are not yet available for US businesses. But you should understand each of these options and how they may or may not work for you.

Your Name in Lights – The Attraction of Crowds

Crowdfunding keyboard key. FingerIt all seems so simple – just put your idea on a website and the dollars come. It’s hard not to get stars in your eyes if you start looking at some of the most successful sites, such as Kickstarter.com and Indiegogo.com. They carefully feature some of the most successful campaigns, because their job is to make you want to use their service. They succeed when their clients succeed, and they are on the lookout for great projects to feature.

The donation-reward crowd funding model has become well known. Small donations, in the cup of coffee size, might get you good karma and perhaps a mention on a website somewhere. Larger “donations” are often just pre-sales of an item – it could be a product or a creative endeavor. A clever writer might presell copies of a book, for example. You like me? You think this sounds good? Buy my book in advance, and I’ll ship you a signed copy AND…

This approached worked brilliantly for Stanford University freshman Daniel Haarburger. He created a prototype product that physically connected a wireless keyboard and a tablet or iPhone, effectively making a laptop. He used Kickstarter to pre-sell the product. His goal was to raise $9,500. He raised $58,869. You can see Daniel’s successful campaign here.

The Secrets to Crowd funding Success: Professional Quality Video and Copy

The keys to winning with Kickstarter are many. Start with a great product or idea, and then get everything right in how you promote.  Create a professional-quality video, great sales copy, the right rewards with the right donation amounts. Using social media tools, forums, and blogs to get the word out.

If you are thinking about using Kickstarter, Indiegogo, or other donation-based crowd funding platform, prepare for it just like any new business launch. Start with The Ultimate Guide to a Successful Kickstarter Campaign, and plan things out before you take the dive. Then spend most of a month promoting it.

Promotion, Promotion, Promotion

Besides starting with a brilliant idea and a product people will want, a professional-quality video, and all the right rewards and copy, there is the next critical step – promoting your campaign. I can (almost) guarantee you that every successful Kickstarter campaign has something else behind it, and that is an entrepreneur who is working his or her network – every day. Yes, they get strangers to contribute. But they also have family members and friends who creatie “social proof” that this is a technology, product, game, app, etc that you want. Daniel Haarburger’s successful Wingstand campaign was heavily promoted by his grandmother, who is a Huffington Post blogger and very influential throughout the Internet. In Kicking Ass & Taking Donations: 9 Tips on Funding Your Kickstarter Project, Todd Anderson points out that finding influential bloggers to promote you can be a key to crowd funding success.

Reward-based crowd funding, if you can do it right, is perhaps the “perfect” funding. You don’t give away any equity, you don’t have to deal with any government agencies, and you get a stable of evangelists right out of the gate. You do, however, probably need either to be a brilliant marketer or to have one handy.

Equity Crowd Funding Enters the Picture – Or Does It?

The Jump Start Our Business Startups (JOBS) act was passed on April 1, 2012, with strong bipartisan support. The JOBS act was designed to do two things – make it easier on small businesses to go public, by relaxing accounting and financial standards for them, and secondly to allow them to sell equity shares through crowd funding.

One outcome of the JOBS act was to ease the financial standards required for investing, allowing individuals with smaller net worth and income to participate in the potentially high return world of startup investing. Once crowd funding is actually legal (which the US Securities and Exchange Commission is now saying will be June, 2013, and others are saying will be 2014, 2 years late), then companies will be able to raise as much as $1 million over a 12-month period, with the following financial restrictions for investors:

  • $2,000 for investors with less than $40K of annual income and a net worth less than $100K;
  • 5% of income for investors with more than $40K and less than $100K of annual income and a net worth less than $100K;
  • 10% of income, up to $100,000 for investors with $100K or more of annual income or net worth.

These are the total investments allowed in all securities. For example, an individual with annual income of $150,000 should be able to invest up to $15,000 in private concerns through crowd funding.

Requirements for companies who wish to use crowd funding are being spelled out. Equity Crowd Funding Nuts and Bolts has a good description of the requirements.

Online Crowd Funding Portals

Besides waiting for the SEC to finalize the policies surrounding crowd funding, the next step is to identify an online portal that can handle your campaign. This is a legal requirement – you cannot do this alone. The brave companies that stepped up to the plate and began building platforms are still waiting for the SEC, which has to be painful, as they have no means of income. David Drake, founder and chairman of LDJ Capital, wrote in Forbes in February of this year, “It seems crowdfunding for equity in the US will take at least another year before it transforms the legislative and regulatory Securities & Exchange Commission Act of 1933 and 1934.” Despite this, he remains very bullish on the concept, “Yet we maintain that the industry is estimated to reach $6 billion in 2013.”

We maintain that the industry is estimated to reach $6 billion in 2013. –David Drake

Because of the delay in SEC rulings, the crowd-funding portals already in existence will likely change and grow by the time they are actually able to accomplish their original goal. Meanwhile, some of these sites have moved into “hybrid” mode while waiting – either acting as angel investment portals (where both the investor financial investment requirements and the investment amounts are much greater) or as donation/rewards sites. Angel investing has traditionally been based on face-to-face relationships, but while we wait for the SEC to make smaller-scale investing possible through crowd funding, the portals are making it possible for qualified angels to learn about broader opportunities.

Some of the sites operating in the US worth checking out include Startupvalley.com, 99funding.com, Indidiegogo.com, Crowdfunder.com, Fundable.com, Bolstr.com (focus on local investors, which is legal now), hyperfund.com, investedin.com, Seedups.com, and Wahooly.com. Crowd funding portals are probably going to be one of the most active and creative areas of growth as this mode of funding evolves and expands beyond accredited investors.

Debt-based Crowd Funding

Debt-based crowd funding differs from the other models only in how the money flows. In this model, which has also been called micro-financing or peer-to-peer lending, the money is paid back to the investors (lenders) on a predetermined schedule. Just like equity-based crowd funding, however, this will be legal for businesses only when the SEC puts the rules in place.

But entrepreneurs can use consumer focused peer-to-peer lending sites to raise small amounts of money for their businesses, assuming that you are willing to stand behind the promise to pay it all back – personally. This is effectively no different from using credit cards or a personal loan to fund a business.

If you do know how you will pay the money back, then check out Prosper.com and Lendingclub.com. You can borrow amounts up to $35,000, with fairly high interest rates, depending on your own credit profile and history. Unlike other crowd funding portals, your identity is kept a secret here, but you do have a few lines in which to tell your story.

Which Crowdfunding Model is For You?

To recap, here are the profiles that best match each crowd funding model:

Donations/Rewards: Best for early stage funding, particularly pre-manufacturing or release, but can be used for any stage of business if a suitable rewards model can be developed

Equity: Best for small- and medium-sized businesses in a growth phase, with ability to demonstrate exponential market potential

Debt: Best for established businesses with stable revenues and assets, but can be used for small amounts to startups if backed by founders.

Although only the Donations/Rewards model is valid at the time of this writing, crowd funding is going to become ever more prevalent as a means to raise business capital.

About Marilyn Walker, Ph.D.

Marilyn Walker is Founder and Lead Consultant at Grow Your Org. She helps businesses plan and manage growth, with a specialty in technology.
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