Crowdfunding: A Start-Ups New Way of Funding
In 2014, 34% of small businesses were unable to get adequate capital to expand or grow. Start-ups normally get funding from venture capitalists, bank loans, credit cards, friends and family, investors, and personal savings. Over the last couple of years, however, start-ups have been seeking more funding than ever before through crowdfunding.
The infographic below, created by the New Jersey Institute of Technology’s Online MBA program, takes a closer look at the rise of crowdfunding.
Comparison of Start-Up Funding Sources Over the Years
In 2006, entrepreneurs had to spend 73% of their personal savings to start a new business. Due to increased capital demand over the last couple of years, this figure has risen. In 2014, entrepreneurs had to fork out 77% of their personal savings to fund their start-ups. Similarly, the amount of money entrepreneurs borrow from financial institutions has increased from 37% to 41% between 2006 and 2014. The increase in capital requirement to start and grow a business forced entrepreneurs to turn to family and friends for more funding. In 2006, the average entrepreneur only required 24% of the start-up capital from family and friends, but this number jumped to 33% in 2014.
On the other hand, credit card use for business funding increased from 21% in 2006 to 28% in 2014. Those who ventured into business with a partner demanded 7% more money from the partner, from only 14% in 2006 to 21% in 2014. It is normal for entrepreneurs to sell an already successful business to venture into a new one. In 2006, these entrepreneurs only used 12% of the proceeds to fund their new start-up, but they had to spend 7% more in 2014. What is more interesting is the fact that the crowdfunding numbers have not changed over the years, which means that entrepreneurs still get only 3% of their start-up capital from crowdfunding.
Angel investors are the best source of business funding especially in a company’s early stages of growth. In 2013, angel investors pumped $24.8 billion into start-ups. Angel investors are usually very exclusive and selective, so getting funding from them can be difficult. For instance, angel investors generally expect a return of 20%-25% on their investment. If the profit projections of a start-up cannot offer this level of ROI, angel investors will most likely take a pass on it.
Venture Capital Firms
In 2014, seed-stage businesses only raised $718.8M from venture capital firms. That is less than half the amount raised in 2010. Venture capital firms normally invest in high-potential start-ups in the early stages of growth. However, funding only takes place after the initial seeding.
Alternative financing Options for Start-Ups
Product Presales – Start-ups that deal in products can pre-sell goods to a targeted audience with the aim of raising funds to take the business to the next level. A great example of this funding option is Pebble Time Smart Watch, which sold over $18M worth of merchandise on Kickstarter to grow the business.
Equity Crowdfunding – This is where members of the “crowd” chip in to fund a business and get shares in the company in return. This is usually done before listing.
Reverse Mergers and Public Shells – Taking a company public through an IPO can be a costly and time-consuming undertaking. To avoid IPO costs, a small business can acquire a public company. The process only takes weeks, instead of months or years that IPO’s are known to take.
Direct Public Offerings – This is the sale of shares to a network of founding members. This can be existing shareholders, employees, suppliers and customers. The shares are sold for cash to raise the required funds.
Peer-to-Peer Lending – In 2014, businesses in the United States borrowed over $75M through peer-to-peer lending platforms.
The Growth Rate of Crowdfunding
Since emerging as a major source of funding in 2009, crowdfunding has grown by leaps and bounds. In 2009, start-ups raised $530M. The figure jumped to $854M, $1.5B, $2,8B and $5.1B from 2010 to 2013 in that order. In 2014, start-ups managed to raise a staggering $10B through crowdfunding. By 2025, crowdfunding is projected to raise over $300B annually throughout the world.
The Fastest Growing Crowdfunding Sites
The top 4 crowdfunding sites are; Indiegogo, Fundable, Crowdfunder and Kickstarter, which have seen funders commit $99M, $154M, $196.9M and $1.6B respectively. The most successfully funded campaign on these crowdfunding sites was the “Coolest Cooler” on Kickstarter. The campaign raised over $13.28M. Initially, the goal was to raise %50,000, but the product was a huge hit.
Tips on Building a Successful Crowdfunding Campaign
Entrepreneurs are advised to set reasonable financial goals. They should also consider reaching out to potential investors before launching the campaign. The campaign should offer adequate, but not excessive, levels of rewards. Eleven levels should be taken as the limit. Fourthly, the campaign should run for a couple of weeks. Consider ending or relaunching the campaign if your goal is not met within a month. Finally, be sure to keep funders and potential funders up to date about your product or service.
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