Crowdfunding pros and cons: which avenue is best?

Over the last few years, crowdfunding has slowly and steadily emerged as a popular and efficient fundraising methods for many small businesses and startups. Crowdfunding has democratized fundraising by allowing companies to raise money to jumpstart their ventures in ways they couldn’t otherwise have achieved. But, as with any other fundraise, executing a successful crowdfunding campaign requires careful planning (often months in advance), hard work, strong execution, outstanding communication skills, and laser-sharp focus. 

Learn more: What is crowdfunding and how does it work

When launching a crowdfunding campaign, many questions come to mind. How  risky is it? How sure are you that the campaign will reach its goal? Is it the right fundraising method for your business?

This article will explain the different types of crowdfunding, lay out their pros and cons, and  help entrepreneurs to decide whether crowdfunding is ultimately the right approach to take when raising funds for their business.

Types of Crowdfunding

Equity (Securities) Crowdfunding

With equity crowdfunding, you raise capital from investors through the sale of securities. On Republic, we use many different types of securities, but most companies use a security developed in-house, the Crowd SAFETM (learn more about how it works here). In essence, you are offering investors a potential share of your business in return for funds. Each security is unique and will give investors specific rights.t

An investor’s return on investment is highly dependent on not just how, but also whether, the business will perform. A wide range of factors will be at play: management acumen and performance, timing, level of competition, industry dynamics and market forces, financial and sales performance, and level of innovation to name a few. Ultimately, the more you can show success through demonstrable market traction, the better your chances will be of raising the funds. If you’re unable to show sufficient traction, you may struggle to attract investors. If your business ultimately fails, you may receive a bad reputation from the failure and investors’ loss of funds. 

Republic is an example of a platform that enables equity crowdfunding. You can browse our current offerings here, or if you’re interested in fundraising, you can learn more about the process here.

Rewards-Based Crowdfunding

Not all forms of crowdfunding require you to give away equity in your company. Depending on your business model, you may also want to consider another way. Rewards-based crowdfunding allows individuals to contribute small amounts of funding for specific projects, and in return they receive a reward, but not equity, in your company. Typically, the more funding an individual pledges to your company, the greater the level of reward they will receive. Rewards are most often (but not always) in the form of a product or service delivered by your company.  However, you should bear in mind that, while rewards-based crowdfunding offers a non-equity reward in exchange for funding, equity crowdfunding campaigns can also offer an additional reward as well as the equity on offer. So, if you’re thinking of going the rewards-based crowdfunding route, you’ll need to be both imaginative and generous in order to compete with companies and campaigns offering both equity and a reward.

Donation-Based, or DonorCrowdfunding

Donation-based crowdfunding is the process of sourcing financing for a project by asking a large number of contributors to donate small individual sums of money. This type of crowdfunding is suitable if you’re financing a charitable cause or supporting an individual or group in order to make an impact on a community or society. That’s why donation-based crowdfunding is popular for many non-profit organizations. However,  in many instances, donation-based crowdfunding can even help an individual or group achieve a particular personal or life goal. In all cases, the “return on investment” comes in the form of the donor’s personal satisfaction gained from contributing to a project that is considered worthwhile.

Now that we have explained the different types of crowdfunding, it’s time to learn what you need to consider before embarking on your crowdfunding journey.

The Pros and Cons of Crowdfunding

Equity Crowdfunding

Pros:

1. You can raise up to $1 million using Regulation Crowdfunding. Equity crowdfunding is a promising new way to raise capital by selling stakes in your business to individual investors. This is especially true if you execute the campaign well, you have an innovative product, strong management, and demonstrable market traction. In the past, only “high net worth” individuals were able to invest, but today, everyone can invest in early-stage startups. Equity crowdfunding has democratized startup investing by reducing the minimum investment ceiling to as little as $10. This allows the entrepreneur to target both accredited and non-accredited (retail) investors.
2. Investors can become valuable advisors to and customers of your business. Many investors have years of business and investment experience and some have built, grown, and exited businesses themselves. There’s a lot at stake when people put money in your business, but with a promising return, the right investors will do all they can to make sure your startup is a success by bringing with them a wealth of value, ranging from contacts, industry knowledge, business acumen, knowing what works and what doesn’t, as well as access to other potential investors. Raising money from a large pool of individuals can be just the start for your company’s journey.
3. There’s no money to repay. In general, since you’re issuing equity in your company, there’s no loan which requires ongoing payments. Just be mindful however that if you’re looking to raise on Republic, our Crowd SAFE features carry certain trigger events and return of proceeds, so our SAFE only converts to equity if the company hits certain milestones. If you issue debt, the debt will have to be serviced and principal returned on a schedule.
4. It can be a great marketing tool. Crowdfunding campaigns have the potential to draw a lot of public attention, especially if you’re running an effective PR campaign alongside it. That in itself can attract more investors, customers, and stakeholders, as well as boost visibility for your company.
5. It can help validate your product or service. When people invest, there’s often an element of emotional attachment to you as the entrepreneur, your story, and your product or service. And many people invest because they would use the product or service themselves.

Cons

1. Equity crowdfunding via Regulation Crowdfunding requires you to apply to be listed on an approved issuing site, such as Republic. If accepted, you will need to file disclosure documents with the US Securities and Exchange Commission, and depending on how much you plan to raise, you may need to have a professional accountant review your financial statements.
2. It is all or nothing. If you fail to reach your target, you’ll have to forfeit the proceeds of the campaign. That’s a significant risk, but for many entrepreneurs, this type of possible scenario is enough to make them step up and ensure that this doesn’t happen and that the campaign is an absolute success.
3. You’re in the public eye. If ever you were told not to be complacent, the rule holds true here. Remember, successful crowdfunding campaigns are also a great way of validating your product or service for your company, but also for your competitors. There is no shortage of people out there waiting for their next business idea, and people will be watching closely whether you succeed or fail. If you succeed - that’s great news. You’ve a good head start, but rest assured that others may follow in your footsteps. 

Rewards Only Crowdfunding

Pros

1. You get to keep your equity. For some entrepreneurs, this is a great avenue, since there are no shareholders to deal with, you get to maintain 100% control of your business. That means you get to decide the direction of your business.
2. No administrative or fiduciary burden.  Since there are no shareholders to communicate with, you’re spared the task of keeping your shareholders up to date, managing all the documentation as well as ensuring you’re continuously SEC compliant. However, it is still important to update your donors and follow through on sending them the promised reward. Regular communication with your stakeholders is just good management practice, no matter what structure you have in place.
3. Your product or service is more important than equity. Many investors prefer to hold shares in a company and reap the rewards further down the line when there is an exit. However, some individuals prefer not to wait that long to see a return. Instead, the appeal of your product or service can often be more than enough, especially if it’s an exciting new product or service innovation.

Cons

1. You’re competing with equity-based crowdfunding campaigns. If you have an innovative product or service, a reward may not be enough to attract money. You, your story and your company must be compelling enough on their own to attract support and no amount of generous reward will disguise that. Also, companies who are offering equity in equity-based crowdfunding campaigns are getting a lot smarter in how they raise funding, and many companies now offer rewards in addition to equity. So your reward must be compelling enough to attract the right individuals to put in money.
2. Rewards are considered a taxable benefit. In many jurisdictions, any form of reward will be treated by the tax authorities as a taxable benefit. Most people are savvy enough to know this and will probably not be deterred from giving to your campaign. However, just as in equity crowdfunding campaigns, the onus is on you as the CEO to exercise your fiduciary duties and openly declare this in your campaign materials. So, check with your financial advisor and/or crowdfunding platform the implications of this.
3. It’s all or nothing/you’re in the public eye. Similar to equity-based crowdfunding, you stand to lose the entire amount if you fail to hit your target. And remember that the outside world is watching to see how successful your product will be - potential good news for your competitors, but a warning to you not to be complacent.

Donation-Based Crowdfunding

Pros

1. It’s great if you’re a non-profit or supporting a social, environmental, or other worthy cause. Crowdfunding is never an easy task, and with donation-based crowdfunding there’s a real chance you could get lost in the noise, competing for the attention of others when trying to raise funding. However, the real upside is that there is already a captive market of donors who prefer to give (part of) their money to a worthy cause. And there are some great crowdfunding platforms dedicated to ensuring you get all the focus and attention you need,  such as GoFundMe, YouCaring.com, FirstGiving and GiveForward.
2. No need to give up equity. Unlike equity-based crowdfunding, you have no shareholders to report to and no potential loss of control. 
3. It’s a great way to build PR and credibility. With so much turmoil in the world these days, “purpose” rather than “profit” is driving many people. In fact, recent studies show that strong mission-led businesses, driven by the desire to be a change for good, do better at attracting top talent. And there is no shortage of non-profit organizations driven by making the world a better place that are attracting a huge following of advocates. 

Cons

1. Increased scrutiny: You might be forgiven for thinking that just because you’ve no shareholders, getting people to support a worthy cause is enough in itself. That’s no longer the case. Today, donors to nonprofits are expecting the same level of management acumen, expertise, and transparency as their commercial counterparts. Since there are no shareholders, a company Director is not bound by the same set of fiduciary duties (as would be the case with shareholders). However, bear in mind that Directors are still bound by anti-fraud laws imposed by each state. And in any case,  - openness, transparency, regular communication, and accountability as always good management practice in any organization. People will always want to know how their money is going to be spent - and nonprofits are no different.
2. Administration costs: In order to stand out and succeed, many “businesses for good” seeking donation-based crowdfunding have become Certified B Corps, Social Enterprises, or Public Benefit Corporations as a way of overcoming 1) above and building strong credibility in the community. Each of these have their own specific legal structures and you need to ensure you meet stringent guidelines. This can be time-consuming. 

Key Takeaways:

Ultimately, success will be down to clearly defining your sense of mission and purpose, then working backwards from there to develop a clearly-defined strategy. Your purpose and your strategy is really the strong foundation for any crowdfunding campaign - evident in the story you tell to the world. If your purpose is driven by an “exit” through trade sale or IPO, driven by a groundbreaking innovation, then clearly equity-based crowdfunding is the way to go. If you prefer to keep control, but need innovative ways to finance the business, then rewards-based crowdfunding might be just the avenue for you. And if you’re driven by purpose and have a passion for making the world a better place, then donation-based crowdfunding is probably the right platform to consider. Whatever avenue you choose, remember that it’s going to be a tough journey - and it will be your strong sense of purpose that will keep you going on days when you’re feeling a little less motivated, so choose your crowdfunding route wisely.

Take a look at our current startup investment offerings now.

This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.