Crowdfunding Your Small Business - What You Need to Know in 2024
[Updated 2/4/24]
Is Crowdfunding for Small Business a Good Idea to Seed Your New Venture?
Do you have a great idea for a new business? Have you developed a product you know will be a success? If so, you may be on your way to opening your small business. However, funding can be a significant hurdle for many entrepreneurs to overcome. Fortunately, the Jumpstart Our Business Startups Act (JOBS Act), signed by President Obama in 2012, paved the way for crowdfunding by easing many security regulations preventing small business owners from raising the funding they needed to open small businesses.
Crowdfunding has become a popular way to raise money for a new product or business idea. Investors see crowdfunding as a way to support small businesses while earning money on their investments. However, there are rules and regulations that entrepreneurs and investors should know before participating in crowdfunding a small business. A Maryland business attorney can help you make sure you comply with the JOBS Act and the subsequent Regulation Crowdfunding adopted by the U.S. Securities and Exchange Commission (SEC).
Advantages vs. Disadvantages of a Crowdfunding Campaign
A Maryland business attorney can guide you through the legal aspects of crowdfunding. However, it is important to understand the benefits and risks associated with a successful crowdfunding campaign.
Easy, Cheap Way to Raise Money vs. Low Success Rate
Even though crowdfunding may be an inexpensive and easy way to raise money for your business, very few crowdfunding campaigns raise sufficient funds to cover all costs of starting a business. Therefore, what should have been an easy, cheap way of raising money becomes a considerable fundraising effort for a small return.
Fewer Guidelines vs. Public Knowledge of a Crowdfunding Platform
When you apply for a traditional business loan from a bank or other lender, you face strict lending guidelines. If your business idea or product is “unusual” or “experimental,” you may not qualify for small business loans to fund a new business venture. However, a successful crowdfunding campaign does not have the strict lending rules and regulations of a bank.
Unfortunately, crowdfunding makes your idea public knowledge. Anyone reviewing your crowdfunding campaign can steal your idea if you have not taken legal steps to protect your invention. Therefore, you may need to pay for a trademark or patent before you raise money for your start-up or risk your idea being stolen.
Rewards-Based Crowdfunding vs. Equity Crowdfunding vs. Donation Crowdfunding
Before beginning your crowdfunding campaign, you must decide between the types of crowdfunding for small businesses: rewards-based, donation crowdfunding, or equity crowdfunding. The methods have unique pros and cons that could make one method better for your situation. A Maryland business attorney can review your situation to determine the pros and cons applicable to your case.
Rewards-based crowdfunding is a way to raise money through donations. Donors receive rewards or incentives for donating to your campaign. On the other hand, equity crowdfunding involves offering an interest in your business in exchange for working capital from investors.
Donation crowdfunding does not require the company to pay back the funds or reward the investor. Instead, the funds are given to the company, usually by family and friends. However, some investors may decide to donate to a small business because they believe in the company’s purpose. This type of crowdfunding is often used for charities and nonprofits.
Is an Equity Crowdfunding Campaign Right for Your Small Business?
Let’s look at how equity crowdfunding campaigns work and what you need to know about equity crowdfunding for small businesses.
How Does an Equity Crowdfunding Campaign Work for a Small Business?
Equity crowdfunding combines the traditional investment in a business by purchasing a stock interest with elements of crowd fundraising. In return for donations, donors receive an interest in the company and equity ownership in the new venture.
Entrepreneurs use online crowdfunding platforms to create a business profile to attract donors. The business profile includes:
A detailed explanation of why potential investors should invest in the company
A business plan and budget
Financial statements
A competitive analysis and marketing plan
The proposed board of directors and company officers
Popular crowdfunding sites include Kickstarter, Indiegogo, and GoFundMe.
The downside of using a crowdfunding platform is the cost. Most equity crowdfunding sites charge monthly listing, payment processing, transaction, and other service fees. Entrepreneurs must include crowdfunding platform fees when they develop a budget for seeking investors for a start-up business or expanding an existing small business.
When the JOBS Act was passed, it permitted only accredited investors to participate in equity crowdfunding. However, in June 2015, an amendment to the JOBS Act permitted non-accredited investors to participate in equity crowdfunding. Non-accredited investors are ordinary people who want to own a share in a business.
The SEC regulates crowdfunding platforms. Therefore, there is some protection for business owners and potential investors. Regulation crowdfunding limits the amount a start-up can raise from equity crowdfunding during the early stages of the business. The cap for accredited and unaccredited investors is $1 million in a 12-month period.
Pros and Cons of Equity Crowdfunding for Investors and Businesses
Investors receive several benefits from equity crowdfunding, including, but not limited to:
Lower Risk – Crowdfunded businesses often allow smaller investments, which can be suitable for investors with minimal funds. When you share the risk of investing in a start-up with many investors, you do not stand to lose a significant amount if the start-up is unsuccessful.
Easier Fundraising – Business owners need not apply for a traditional bank loan, which means they need not go through the rigorous application process for a small business loan. Furthermore, gaining approval to list a business on an equity crowdfunding site is generally easier than qualifying for a business loan at a bank.
Investor Input – Investors have some say in the business operations as shareholders. This element of equity crowdfunding may benefit investors, but it could make it more difficult to take a start-up in the direction the owner envisioned.
Less Pressure on Company Management – Because numerous investors own the shares, there is a smaller chance that one or two investors or groups control a large voting block of the shares. Therefore, management need not worry as much about shareholders using their voting power to control business management and operations.
No Debt Incurred – Unless traditional small-business capital funding, crowdfunding does not result in debt for the company. Small business owners raise funds by selling ownership shares in the company instead of taking small business loans.
However, the company must follow federal and state securities regulations. Therefore, consulting a Maryland business lawyer when setting up equity crowdfunding is wise. If you do not have experience with the legal and financial aspects of starting and owning a business, it is wise to see legal advice early in the process. An attorney can help you avoid some of the pitfalls and problems new businesses encounter that prevent them from having successful campaigns.
Can Reward-Based Crowdfunding Work for Your Small Business?
If you do not want to sell shares of your company to raise funds for a start-up, you might consider reward-based crowdfunding. Let’s review some of the key elements of this type of crowdfunding campaign to gain a better understanding of the benefits and drawbacks.
What Is Rewards-Based Crowdfunding?
Instead of receiving an interest in the business, this type of small business financing involves providing investors with a product or service in exchange for their financial donations. You begin by listing your company on a crowdfunding platform.
Your listing describes the company, including the product or service you offer. In return for donations, you offer investors something in return. It could be one of your products or a free service. The offer need not be substantial.
These campaigns are usually suited for small start-ups that don’t qualify for a traditional small business loan. Anyone can contribute to rewards-based crowdfunding campaigns - friends, family, business partners, customers, strangers, etc. Some entrepreneurs use social media to raise awareness of the crowdfunding campaign.
As you can imagine, rewards-based crowdfunding campaigns are the easiest and least expensive way to raise capital for a start-up. There are no credit checks, collateral, or business experience required. The process is simple, and you retain all equity and control of your company.
However, rewards crowdfunding may not generate large amounts of money. Therefore, you may not reach your goal and must forfeit any funds raised. Furthermore, providing information about your products and services online could result in your ideas being stolen unless you have taken steps to protect your ideas with patents.
How to Choose a Crowdfunding Platform for a Successful Crowdfunding Campaign?
Choose a platform that is SEC-registered. Even though there are some stipulations that investors and business owners must follow when using the site, a platform provides more protection for all parties when regulated through the SEC. Registered crowdfunding platforms must be based in the United States of Canada.
Other considerations when choosing a crowdfunding platform include:
Your target market. Choose a platform that appeals to your target market and is easy for them to use.
The type of business. Some platforms are more suited for specific types of businesses. For example, Indiegogo is a good platform for businesses that offer to pre-sell a product or service. Alternatively, Kickstarter is a good platform if your company’s services and products have a visual component.
The amount of money needed. Consider the platform’s requirements and restrictions in light of the amount of money you need to raise from crowdfunding. Some sites have shorter fundraising periods.
The platform’s features. Consider what you need the platform to do for you. Base your decision on whether a platform has the necessary features to meet your needs. For example, do you need the platform to integrate with other software or be eCommerce enabled?
The support you receive. Choose a platform that offers the level of support and service you need. Some platforms have very little support, while others offer extensive support for business owners using the platform to raise funds.
Ability to grow with your company. Platform scalability is crucial. As your company grows, the platform needs features that meet the needs of your expanding business.
Platform fees and costs. Crowdfunding sites include free platforms, but some sites can be very expensive. Read the fine print and consider all fees and expenses before choosing a crowdfunding platform for your start-up.
A crowdfunding platform might be the best way for your start-up to raise capital. However, there are negative aspects to consider. The risks associated with some platforms include:
The fees and costs
The time commitment required
The lack of support
The conditions and terms of the platform
Low success rates
Negative reputation
A Maryland business lawyer can help you choose a crowdfunding platform that meets your needs, provides the benefits you need, and has minimum risk for your company.
Tips for a Successful Crowdfunding Campaign
Ways you can increase the chance of creating a successful crowdfunding campaign include:
Research the competition to get a sense of what is and is not working for them.
Factor in the costs and expenses of crowdfunding in your business budget.
Focus on the launch. Getting off to a great start gives your crowdfunding campaign momentum.
Be creative in the rewards that you offer and how you pitch your business to investors
Use social media to promote the campaign and educate and update people about various issues and news related to your project.
Deliver what you promised on time. If you promise a reward, ensure it is complete in the investor’s hands-on time.
Finally, seek legal advice and talk to experts on crowdfunding campaigns. Understanding the legal and business aspects of crowdfunding before you list your company on a site reduces the chance you might make costly mistakes that could hurt your business.
Do You Need a Maryland Business Attorney for Crowdfunding Advice?
While you do not have to consult with a Maryland business attorney before organizing a crowdfunding campaign, a seasoned business attorney can help you understand the crowdfunding process and avoid costly mistakes. Whether you are an entrepreneur or an investor, learning everything you can about crowdfunding makes sense to ensure you make wise choices that decrease your risk and increase your chance of success.
Contact Thienel Law, LLC today for the legal counsel you need and peace of mind when dealing with business matters. Maryland business attorney Steve Thienel is committed to helping clients in Maryland, the DC Metro area, and Virginia.
