What is crowdfunding for start-ups?

Crowdfunding has raised millions of pounds in the UK. Discover how crowdfunding can help your startup raise the finance needed to launch and grow.

Crowdfunding has emerged as a popular way for startups and small businesses to secure funding outside of traditional routes.

Forget seeking out venture capital firms, braving the Dragon's Den or going to your bank cap-in-hand for a business loan.

Discover how crowdfunding can help your startup raise the finance needed to launch and grow.

What is crowdfunding?

Crowdfunding for small business is democratising how startups raise money.

Investing in a new company was previously the preserve of professional investors.

Crowdfunding throws wide the doors so anyone can make a micro investment in a new business that interests them.

Originally a way for more unique, quirky and less traditional business ideas to secure funding, crowdfunding for small business has grown rapidly.

It works by allowing large numbers of people - the 'crowd' in crowdfunding - to individually invest small, affordable amounts into businesses.

With lots of investors contributing, these small amounts add up to a large, pooled investment that can be used for various purposes by a small business, such as to bring a prototype to market.

Crowdfunding can raise huge sums.

According to Business Insider plenty of UK businesses have secured millions of start up money using crowdfunding platforms.

In 2017, Hopster raised £4.8 million on Venture Founders for its ad-free TV and learning app for kids, while businesses such as JustPark raised £2.2 milion on CrowdCube and pay-as-you-go workout business Core Collective raised £2 million on Seedrs.

What is crowdfunding for small businesses and how does it work?

Online crowdfunding platforms allow businesses to create a fundraising campaign.

This is a pitch to investors that includes an overview of the business, business plan, management details and details of the money they want to raise.

Depending on the type of crowdfunding platform - such as equity crowdfunding or rewards-based crowdfunding - the campaign will put equity or rewards up for grabs in exchange for their investment.

Investors pledge money during the campaign.

Some crowdfunding platforms operate an all-or-nothing approach: if the fundraising goal isn't achieved then no money is invested in the business and investors walk away.

Some platforms such as equity crowdfunding may go ahead and invest the amount pledged at the end of the campaign even if the target wasn't hit.

The crowdfunding platform takes a cut of the money pledged and passes the rest onto the start up.

Crowdfunding isn't just about raising money.

Its community of investors can be a great way to test a product idea and get market insight.

If there's zero interest in a pitched idea, it may be a sign to change course.

Ask for feedback from potential investors as to why they gave you a pass.

A word of warning.

Crowdfunding isn't for the faint of heart.

You'll need to actively pitch your business and drive interest to hit your funding goals.

Once hit, you'll need to work long and hard to keep investors updated and engaged, as well as growing your business.

Platforms for crowdfunding

There are different types of crowdfunding platforms.

All operate in a similar way but take a different approach to the return investors get.

Equity crowdfunding, for example, invests in a business in exchange for shares in the firm.

Peer-to-peer crowdfunding expects investments to be paid back to investors with interest.

Deciding on the best crowdfunding platform is crucial to successfully raising funds and ensuring you're not giving away too big a stake in your business.

There are several types of crowdfunding platforms: equity crowdfunding, peer-to-peer crowdfunding, rewards-based crowdfunding and donation crowdfunding.

What is equity crowdfunding?

An equity crowdfunding platform, such as Seedrs and CrowdCube, allows small business owners to sell shares in their company in exchange for funding.

It's a similar approach to raising money from venture capital firms or angel investors, but with lots of smaller investors buying tiny chunks of equity in your business.

Equity crowdfunding involves a start-up launching a fundraising campaign.

This outlines the level of equity available, and how much money it is trying to raise - essentially valuing the business.

For example, if a business puts up 25% of equity and wants to raise £250,000, it is valued at £1 million.

Investors can then buy a portion of the available equity.

Benefits and downsides of equity crowdfunding

Good quality investors

Many angel investors use the platforms full time, so, along with financing, a start up can benefit from angel support and advice.

Once in, investors may continue to invest in the business over the longer term.

Pooled investments

Some equity crowdfunding platforms pool all the investments from individuals into a single investment that buys shares in your business.

Therefore you need to only deal with one point of contact rather than lots of individual investors.

Larger investments

Equity crowdfunding can raise serious investments.

There's the potential for larger sums invested due to equity and pooled funding.

Many platforms have a minimum investment of £1,000, compared to other crowdfunding types where investors can chip in as little as £5 into a business.

Increased transparency

A potential downside is the need to disclose lots of information about your business.

You'll need to share details such as turnover, profit, financial forecasts and management approach with all investors.

Expensive money

You are giving away equity in your business in exchange for finance, making raising capital expensive especially as your business grows in the longer term.

Platforms include CrowdCube and Seedrs.

What is peer-to-peer crowdfunding?

Peer-to-peer crowdfunding platforms, such as LendingCrowd and FundingCircle, pool investments and lend money to businesses.

The expectation is that the startup will be successful and the crowdfunded investment will be paid back along with interest.

It's a similar approach to getting an unsecured loan from a bank. It's sometimes referred to as 'debt crowdfunding'.

Benefits and downsides of peer-to-peer crowdfunding

Unsecured funding

As you're not issuing equity or shares, nor tangible assets such as plant equipment or premises, it's effectively an unsecured loan.

Default and you won't have assets exposed to investors.

Niche funding

Peer-to-peer crowdfunding is more suitable for less mainstream businesses.

It tends to attract investors interested in niche businesses that would find it difficult to secure traditional funding.

Increased pressure

With the need to repay investors with interest and investors having a keen interest in your day-to-day progress, it can result in added pressure for a startup.

The higher interest rates can place an additional strain on resources.

Platforms include LendingCrowd and FundingCircle

What is rewards-based crowdfunding?

Rewards-based crowdfunding platforms such as Kickstarter and PeopleFundIt allow businesses to reward investors in ways other than simple equity or interest.

Rewards can be the chance to test prototypes, lunch with the founders or getting one of the first models off the production line.

Rewards are usually tiered, so the more money someone invests, the greater the reward.

Benefits and downsides of rewards-based crowdfunding

Cheap money

There's no equity or interest swaps in exchange for funding and as rewards can be inexpensive, it's a cheap way to raise finance.

Create a customer base

Rewards-based investors tend to be enthusiasts or fans of projects or campaigns, making rewards-based crowdfunding suitable for more creative projects, innovative products and software such as video games.

Investors are usually happy to take part in market research and are keen to buy the completed product as well as act as advocates for your business.

Time consuming

Rewards-based crowdfunding is usually all-or-nothing.

If the fundraising goal isn't reached, no money is invested.

This means you can spend a lot of time trying to drum up investors and creating rewards that ultimately don't result in a single penny of investment.

Platforms include Indigogo and Kickstarter.

What is donation crowdfunding?

This is the best way to raise finance through the sums are usually small.

Investors simply donate to your business.

You'll need to update investors on progress, but any donations you get are yours to keep.

Benefits and downsides of donation crowdfunding

Free money

Donations are exactly that: free money given to your business to help it succeed.

Small investments

Because donations are usually by individuals attracted to your business idea, it's similar to like tossing spare change into a hat. Don't expect to raise huge sums through donations.

Niche businesses

Donations are usually made by people who are supporting social enterprise activities or businesses that support local communities, rather than mainstream limited companies.

Platforms include GoFundMe and Crowdfunder.

How to get started with crowdfunding

To get the best from crowdfunding, you'll need to consider the following:

Business case

You'll need a compelling business case, a detailed business plan, sound financials and robust market insights.

Choose the platform

Investigate different crowdfunding platforms and decide if you're offering equity, interest or rewards to investors.

Look at similar business pitches to yours.

How much did they raise? How many backers did they attract? Which platforms do similar businesses use?

Read the terms and conditions and check fees and the legal commitments you're making.

Take independent financial advice before you launch a campaign.

Pitching

The pitch matters.

You need to capture the imagination of investors, demonstrate commercial potential and keep it human with presentations by the team.

Remember, people invest with head and heart.

Set rewards and goals

Establish what investors will get - from equity to access to initial products - and what funding targets need to be met to trigger investments.

Engage the community

Crowdfunding is about community.

Be active on forums, talk to potential investors, post updates and use social media to tell people about your campaign to drum up support.

Get seed money

Investors like backing a winner.

Get friends and family to make a few 'investments' in your business on the platform so it looks as if people are keen to chip in.

A few pounds in the campaign fund can spark further interest.