Small companies tend to face a lion’s share of challenges during or after start-up. These hurdles can vary based on their business model.

Commodity services, such as dry cleaning or landscaping, have a large consumer base but take time to establish brand identity and loyal customers.

Niche products have smaller markets that could make it easier to gain a presence. However, consumer targeting and market data for wart removers, tattoo cream or other specialty products may be difficult.

Despite unique obstacles, business financing is a common issue faced by most entrepreneurs. Lack of capital, among others is a primary reason why small businesses close their doors.

Getting a business loan requires the credit and collateral many small companies do not have. Many banks will simply not lend to industries common among start-ups.

These include:

  • Restaurant and Nightclub Financing (high closure rates and capital requirements)
  • Construction Contractors (seasonal cash flow, sensitive to the economy)
  • High Tech Startups (unproven business models)

So, if you are limited by industry and/or credit history, where can everyday entrepreneurs turn for capital?

Crowd funding may offer the best solution.

Crowdfunding guide

Overview

Private equity used to be thought of in terms of multimillion dollar venture capital. (VC) Crowd funding has changed both the scale and goals of private equity.

In terms of scale, crowd funding features:

  • Smaller Capital Needs- Small business needs such as equipment loans or working capital. Million dollar amounts have also been raised for high tech startups.
  • Easy Qualifying-Crowd funding platforms will verify your business exists and other basic criteria.
  • Broad Exposure- Your funding request will be seen by countless visitors on different platforms.
  • Smaller Investors- $25 and up is typical. With small amounts, investors are less risk averse.

Equity vs. Donation Based Crowd Funding

Venture Capitalists will demand a return. This may be equity shares in the business or a cash return.

Equity crowd funding (ECF) follows this model on a small scale. ECF repayment may include:

  • Interest Payments
  • Ownership Stake (as small as 1 share)

Donation based crowd funding uses social equity or offers non-financial incentives. Examples include:

  • Free Products or Services
  • Certificates of Appreciation (no, seriously)

Strategies for Crowd Funding

Businesses can use crowd funding in savvy ways beyond raising money.

Proof of Concept (POC): POC is a vital part of venture capital. Facebook and Twitter are examples of brand names that had to show POC. Crowd funding helps state your case of why an innovation can be successful.

In essence, crowd funding allows you to say: ‘Here is my new web app or product and this is why it has value in the real world’. This offers an alternative to traditional banks that frown on abstract concepts.

Validate Ideas and Demand: For any business, customers must want the products and services. Crowd funding is a way to gauge interest in your product.

For example, a company that offers their widget in exchange for capital may realize there is little interest in the product. In this way, crowd funding allows people to vote for ideas with their dollars.

Crowd funders vote with their money
photo credit: 401(K) 2013

Best Practices

Don’t Slouch: You should present a compelling case for why the money is needed. Much like any business loan, investors must still want to invest in your idea.

An explanation of how the money will help your company is preferred to tales of bad luck. While goodwill is important, not many folks will give to a lost cause, even in small amounts.

Consider a positive spin on how funds will help the business thrive. For instance, money to buy a new pizza oven allows you to meet customer demand.

Other positives such as years in business, employees or even specifics on revenues may be used. At this point, you may mention that many banks will not lend to your industry or new businesses, etc.

Many crowd funding investors understand business financing is difficult and are motivated to contribute for this reason.

Do as You Promise: It is important to follow through on your promised repayment. Your business reputation can be damaged very quickly with poor follow through.

The site may expel your business or assign the company a poor rating. This takes away a crucial source of low cost funding. Frustrated investors may take to social media and voice their concerns.

Best practices for picking repayment include:

  • Be realistic- Remember that crowd funding investors want to help. Make your story the incentive, rather than purely a reward.
  • Follow through-Ensure that investors are paid in whatever way promised.

Summary

Entrepreneurs turn to non-traditional financing for various reasons. Crowd funding offers common benefits for different challenges.