Raising financing for business startup, growth and working capital needs can prove a massive time-suck and even a distraction away from true business growth. But slow growth of an operating business beats the alternative–no business at all. Luckily today’s world offers a broader selection from the proverbial fundraising buffett. Alternative financing options abound and the number of options is not slowing anytime soon. This boon for business founders and entrepreneurs simultaneously requires greater education on both the benefits and detriments of both traditional and alternative small business finance. The release of each new and creative financing option brings with it its own shortcomings. There will never be a one-size-fits-all approach to business finance. Consequently, matching individual business needs and goals to the financing options available will require a complete understanding of all the options available and how they impact the operations of the business. Here we’ll focus strictly on some of the differences between equity and rewards-based crowdfunding and the features that may push business owners to one over the other.
The Kickstarters and Indiegogos of the world have some of the best success stories for financing small business ideas. The biggest obvious benefit to the rewards-based crowdfunding scene is that founders aren’t forced to give up equity in their company. The poster child of this phenomenon is the OculusRift. After raising nearly $2.5 million from the company’s Kickstarter campaign, the company was sold just 23 months later to Facebook for some $2 billion. The story here is self explanatory. The founders and original shareholders in the Oculus virtual reality had a nice payday, but all the backers got in return were either their units or, worse still, a lesser reward. Had the deal included equity, the outcome would have resulted in life-changing payouts. Fortunate for the startup shareholders, unfortunate for the backers.
Rewards-based crowdfunding is also much more suited for startups with a specific project, product, game or franchise. It’s a way to test the true consumer market if such a product is worth its weight in hype. It’s certainly helpful for existing businesses as well, but plays well toward something new that could hit a tipping point for virality, especially when it comes to raising the sizes that come from some of the most successful campaigns. Rewards funding is also geared more toward consumer-based businesses. Never would you see a the owner of a niche manufacturing plant, a convenience store or a oil distribution company post on a rewards-based crowdfunding site. It plays to the wrong audience, the wrong demographic.
Where rewards-based crowdfunding fails, equity crowdfunding picks up some of the slack. It plays better with existing businesses whose products or services may lack some of the sexiness we’ve seen on popular rewards-based portals. And while the downside includes some equity dilution with the private placement, it typically lends itself better to sophisticated investors with comfort in a specific market niche. Such an investor could prove more beneficial than the capital s/he provides to the campaign. Networks, experience and personal contacts may make all the difference in the success or failure of the business.
Currently, most equity crowdfunding campaigns are attracting less than 20 investors, which lends itself to a much more manageable group. While we certainly shouldn’t place backers and investors in the same bucket, the post-campaign time demand from said groups are worth noting. For instance, having 2,000 backers in a rewards-based campaign is likely to prove a larger drain on resources than say five investors with deep pockets from an equity-based campaign. Both groups can be unforgiving and unrelenting when it comes to delivering on promises touted in the campaign, but the larger the group, the more resources will be needed to fend off the fray.
The statistic that 8 out of 10 startups fail is fairly accurate. That’s why many expect the future growth in crowdfunding is likely to lend itself more to existing, successful businesses seeking growth or working capital financing in exchange for equity, debt or warrants. It’s a more plausible scenario because investors like safe bets with nearly guaranteed cash flows. When the dust finally settles, we’ll certainly see some more big wins like Oculus Rift, but the safe bets in existing businesses, product lines and business teams are likely to provide less risky returns than the high risk gamble of putting all your crowdfund investment into a bunch of mobile app or gaming startups. In essence, some equity crowdfund investments will look more like debt instruments or traditional private equity while others will mirror traditional venture capital plays.
A note on the full implementation of crowdfunding: While we’re not at the stage where online fundraising allows for non-accredited crowdfund investors to purchase securities using a credit card, I expect we’ll be there soon enough. Full equity crowdfunding will certainly present its own challenges, but until it’s fully implemented, the aforementioned “pointers” apply.
Shareholders should always keep in mind that neither equity or rewards-based crowdfunding are mutually exclusive. Both forms could be used in tandem or at separate intervals to help provide a boost to the business or a specific project. The timing, nature, structure and target demographic of either type of campaign is likely to be wildly different. The knowledge of being successful on Kickstarter is likely not going to transfer over when you need to create a pro-forma financial statement for Equitynet. Most consultants good at drafting a private placement, including attorneys and accountants, are certainly not going to be good at assisting with a creative video for your campaign.
The best approach for any small business deciding what type of crowdfunded finance is right for their particular situation will always be an “it depends” scenario. It does help to know the ins and outs of both options to ensure shareholders make the right decision relative to their individual situation and business needs.