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Distinguish Crowdfund Investing from Other Types of Financing

Before you dig deeper into what crowdfund investing is and how you can tap into it for supporting a new venture or a small business, you should have some sense of how it differs from the types of funding that have previously been available to businesses.

Self-funding

Self-funding your business differs significantly from getting crowdfund investing support. One involves your own wallet, and the other involves a whole bunch of other wallets.

With that technical explanation out of the way, here’s how crowdfund investing changes your need to self-fund your business: It doesn’t. The first dollars invested in your business should be your own money, and crowdfund investing doesn’t alter that fact. If you’re going to launch a business, you need to believe in its success all the way down to your core.

To show this belief, you need to invest in your own company. If a potential crowdfund investor were to look at your campaign and see that you’re starting off with $0, this fact would be a big red flag. By investing your own money, you demonstrate that you believe in yourself and your business model.

How much of your own money should you risk? It’s important to understand how you work under stress with your money on the line. Aim to invest an amount that will give you just enough stress to drive you to work hard, but not so much stress that you’ll be a worried mess and distracted from productivity.

Credit card financing

You start your business with your savings, but maybe your budget doesn’t reflect every item you need. Or maybe you have opportunities to invest faster than you had planned. Either way, after your savings is tapped, the easiest source of funds is your credit cards. Unfortunately, credit cards are usually the most expensive form of debt that a business can utilize.

If you use credit cards to fund your business, pay them off each and every month. If you can’t do so, use them only when absolutely required. Otherwise, when you seek funding from a bank or another resource, your outstanding credit card debt will be a strike against you.

Can crowdfund investing reduce the necessity of relying on plastic? Very possibly — if you can plan far enough ahead to anticipate your upcoming expenses and spot future opportunities for growth before they’re in your face and begging for cash. Whereas credit cards are quick fixes that often wreak long-term financial havoc, crowdfund investment campaigns demand longer-term planning and commitment.

Bank loans

Bank loans have traditionally been a source of capital for small businesses, but one of the reasons that Title III of the JOBS Act passed is that banks are not lending like they used to. Capital is not flowing from the people who have it to the people who can use it to grow businesses and create jobs.

To qualify for a bank loan these days, you likely need a lot of collateral to secure your loan, three years of business financials to support your case, and an ongoing relationship with your bank. If you’re an entrepreneur or a new small business owner, chances are, you don’t meet these qualifications.

Crowdfund investments can be structured in various ways to suit the specific needs of your business. In many cases, a crowdfund investment campaign will offer investors an equity stake in the operation (meaning, they own stock in your company and earn dividends if you make a profit). However, your campaign could be structured so that your crowd is actually giving you loans, and you’re repaying those loans with interest over a set amount of time.

Clearly, the way in which you choose to structure your campaign determines whether your crowdfund investments closely mirror the services that banks provide through small business loans (in the case of debt-based crowdfund investing) or are quite distinct from bank loans (in the case of equity-based investments).

Should you look to crowdfund investing to completely replace your need for bank loans? Probably not, even if you opt for a debt-based crowdfund investment structure. Instead, your goal may be to seek a combination of both types of financing (in addition to self-funding and any other financial resources you can muster).

Private money

What exactly is private money? It’s money that comes from companies or very wealthy individuals — people called accredited investors by the SEC — who, just like regular investors, want to maximize the returns of their investment portfolios.

Private money organizations aggregate capital from a mix of accredited investors (including companies and financial institutions) for the purpose of making investments primarily in private companies or nonpublic offerings.

The goal of these organizations is to pool large amounts of investment capital and employ investment experts who can find and invest in great deals that will deliver higher rates of return than more traditional investments in public companies. (Of course, these deals also carry a lot of risk.)

There are three types of private money investors, which differ based on the size of the investment made and when during the company’s lifecycle the investment is made. At each stage, these private investment firms provide not only capital, but also advice, connections, merger/acquisition targets, and external accountability and expertise to help companies succeed.

Here’s a brief overview of the three types of private money entities:

  • Angel investors: These people usually make bets on companies at their earliest stages (sometimes called seed-stage investments) and can play the role of a guardian angel. Angel investors usually form groups to allow them to jointly review investment opportunities, share information, and provide a potential pool of dollars that will attract good company founders who want both expertise and cash.

    Typically, these types of investors have some experience in entrepreneurial ventures and want the excitement of being part of something and helping it succeed. Individual angel investors typically make investments in the $25,000 to $100,000 range, which are small compared to later-stage investments.

  • Venture capitalists: These investors (which are usually firms, not individuals) often invest between $1 million and $10 million in companies that have begun to grow out of the seed stage and are showing traction and results in their market space.

    The companies may or may not have revenue but likely are not profitable because they’re spending all they make, in addition to the money that’s invested in them, in order to grow as quickly and effectively as possible. Venture capitalists invest in companies that are believed to have very high growth potential and need capital to be able to scale quickly to take advantage of the market.

  • Private equity investors: These firms tend to invest even larger amounts than the venture capitalists and look for more established companies with profits and successes that are looking for growth-stage capital.

Today, the lines between venture capital and private equity are fairly blurry. Many times, the way the firm wants to position itself from a marketing and strategy perspective makes the distinction (as opposed to what the firm invests in).

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