Is Crowdfund Investing Right for Your Business?
You need to target your fundraising efforts to sources that are the best fit. Think about what your business is offering from a product, service, and investment perspective. Think about where you are now and what type of financing option would have the most appeal to the type of investors you’re seeking.
Also, as you think about your growth trajectory, consider how many rounds of funding you think you’ll need over the next few years to reach your growth goals. Consider which sources make the most sense for repeat financing and which are most likely one-time sources of support only.
Crowdfund investment, by law, is all-or-nothing fundraising. This means that if you set your fundraising goal at $100,000 and you raise $99,800, you don’t get a dime. You must set a realistic goal in order to succeed, and you must be willing to work hard on your pitch and your follow-up communication with potential investors.
What tells you whether crowdfund investment makes sense for your business? For starters, these things must be true:
You’re comfortable in the social media world and have existing social networks via Facebook, Twitter, LinkedIn, or other sites.
You’re looking to raise $1 million or less from this source.
You have an idea that you can clearly communicate to your friends, family members, and other potential supporters.
Your idea solves a problem and, therefore, has a target market that you can define in your pitch.
You’re willing to be transparent with potential investors about who you are, why you’re passionate about this idea, and why you know you can succeed.
If you can say with confidence that all these things are true for you, then crowdfund investing may prove to be a vital resource for your company. If that’s the case, you need to determine early on whether you prefer to raise money via crowdfund investing by taking on debt or by selling equity.
Take on debt
If you borrow money to buy a new car, you sign a piece of paper that says you’ll pay back that loan over a certain number of years at a specific interest rate. You’re signing a personal loan or note — a debt instrument. You’re agreeing to make payments every month on your obligation until that loan is paid off.
Businesses can borrow money, too, by taking on debt. As with personal loans, it’s critically important that your business has money to pay its loan obligation each month. Hence, debt isn’t something that startups or early-stage businesses use often because they generally haven’t started to generate revenue and don’t have money to pay their loan.
However, if you do have a steady flow of cash, and if borrowing some money will allow you to expand or grow faster (hence, leading to more income), borrowing money from investors may be the right thing for you. Doing so not only allows you to use other people’s money to grow but keeps you in control.
Because a debt-based crowdfund investment allows you to raise funds without giving up equity in your business, certain types of businesses (such as Main Street retail shops and restaurants) may prefer to offer debt instead of equity. That’s because they are quick to generate cash but most likely won’t have a splashy initial public offering (IPO).
Businesses can deduct the interest they pay on their business loans. The interest is deducted from the sales they make when calculating their profits. (That’s a big plus to borrowing money.)
If your business borrows money from crowdfund investors, you may be on the hook for a set amount of interest and principal each month, or you may offer revenue-based financing. In the revenue-based financing model, you agree to pay investors a percent of your revenue each month for a set period of time (for example, five years). A restaurant or a dry cleaner may prefer revenue-based financing because it allows them to pay less during months when sales are slower. (When business is great, the payback bumps up.)
Either way, the repercussions of not being able to pay off debt can be severe, so you absolutely don’t want to borrow more than you can afford to repay.
Offer equity participation
If you have potential investors who want (and will likely demand) a share in your business, and if you’re willing to exchange equity in your business in order to grow it, this method of crowdfund investment can be a great way to go. Keep in mind that selling equity means taking on long-term partners. Bringing on investors is a bit like jumping into bed with someone, so make sure you’re ready to get intimate before you decide to sell equity. You don’t want to wake up and regret the decision!
Equity can come in many different forms like common stock, preferred stock, warrants, and options. Equity comes with certain rights and benefits for the investors; these benefits differ depending on the type of equity offered, but certainly a biggie is that the investors benefit from an increase in company value. The benefit of equity to a business is that it doesn’t have to be paid back to investors immediately.
The biggest disadvantage for a business that offers equity is this: As owners, the investors have a say in the business and can vote on major business decisions. Never hand investors more than 50 percent ownership of your company for this reason. On the flip side, giving them some skin in the game will make investors more likely to become evangelists for your business.