What small businesses should know before turning to crowdfunding

The lingering impact of COVID-19 on small business Bruce Frisko speaks with retail analyst Bruce Winder about how businesses still face issues raised by the COVID-19 pandemic.

Have you been planning to start your own business or launch an innovative new product or service?

Starting a business usually requires some type of up front investment. Traditionally, you would need to use your own personal savings, request a business loan from the bank, or find people willing to invest in your idea.

In today’s economy, though, crowdfunding is becoming an increasingly popular alternative. Below, I’ll explain a bit more about how crowdfunding works and why more startups are turning to it.

What is crowdfunding?

Crowdfunding is an innovative financing approach where individuals or businesses raise funds for a project or venture from a large number of people, typically via the internet. This model democratizes funding by allowing anyone to contribute financially to the project they believe in.

The main types of crowdfunding models include:

Reward-Based: Backers receive a tangible item or service in return for their funding.

Crowdfunding in Canada has seen significant growth, becoming a tool for startups and small businesses looking to bypass traditional banking and venture capital routes.

Platforms like Kickstarter, Indiegogo, SeedInvest, and GoFundMe are some of the leaders in this space, allowing small startups to pitch their ideas to a wide range of investors and potential supporters. Crowdfunding has even been used to successfully fund film and art projects.

Thanks to social media, it’s easier than ever to get your idea out there and receive funding from people all around the world, from everyday people who simply believe in your idea to angel investors looking to diversify their portfolios.

Why small businesses are turning to crowdfunding

There are several interesting reasons why more businesses are leaning into crowdfunding as an alternative to traditional financing methods.

1. It can be easier than obtaining a traditional loan

The harsh reality is that entrepreneurs don’t have a high success rate: 21.5 per cent of small businesses fail within their first year; 50 per cent of businesses make it to five years; and only about one-third of businesses make it to the decade mark, according to small business publication Made In CA.

This means that even in favourable economic times, lenders take a major risk when they offer small business funding -- especially to startups with an unproven business model. Generally speaking, lenders prefer to lend money to businesses and entrepreneurs that are already established and have a history of turning a profit.

The future of Canada’s economy is still somewhat uncertain, leading many lenders to err on the side of caution, making it harder for startups to obtain traditional funding for their ideas.

2. Interest rates are high right now

Even if an entrepreneur were able to obtain a traditional business loan, today’s high-interest rates would leave them paying back a lot more than they originally borrowed.

This can be even more problematic for individuals thinking of funding their small business with credit cards, which charge compounding interest.

Crowdfunding provides an alternative means of obtaining startup funds without compounding interest and the high-interest rates charged by banks. While you may have to pay some interest back to your investors, it may be lower than what you’d have to pay a bank.

3. Helps businesses grow a community

Perhaps one of the biggest reasons that more businesses are turning to crowdfunding is that it’s a great way to build a community of supporters who are, quite literally, invested in your product. When your supporters are financially invested in your idea, they’ll go the extra mile to help it succeed, by helping physically or promoting it in their own circles.

How does crowdfunding work?

Crowdfunding is a relatively simple process.

First, you’ll want to clearly outline your idea and your goal. Then, you’ll want to create milestones and detail how the money you’ll receive is to be used (i.e., obtaining licences, research and development, marketing, etc.).

Then, you’ll want to create an account on your crowdfunding platform of choice, write out your idea, and introduce the world to it. During this process, videos, pictures, diagrams, and details are very important.

The more clear you are about why you need funding and how it’s going to be used, the more trust you’ll build with potential investors.

Additionally, it helps to have a compelling story behind your idea. People often invest based on their emotions and interests. Explain why the project is so important to you and how it can benefit others. The more that you (as the founder) appear to be sold on your idea, the more others will be sold on it as well.

Should you crowdfund your business idea?

If you have an innovative business, product, service, or creative idea that you want to bring to the market, crowdfunding may be the best way to make it happen. The most important thing is that you have a very clear plan of action, set deadlines, and communicate openly with your investors.

Leveraging social media communities can also be another great way for your idea to gain traction.

Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.

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