by LawInc Staff
September 19, 2017
10 years ago it was almost impossible to get random strangers from across the globe to invest in your project, invention, or business.
But that’s exactly what tens of thousands of entrepreneurs have done in the last couple of years using so-called “crowdfunding” sites.
These websites allow strangers to invest in just about anything in exchange for future products, discounts, equity, or even just the prospect of being part of something exciting.
The premise is simple: set a fundraising goal (e.g., $500,000), and then try to get investors to pour money into it. If your goal is met by a certain date, you get the proceeds, but if the goal is not met, you get nothing.
This formula has already helped thousands of innovative ideas come to fruition on popular sites such as Kickstarter, GoFundMe, and IndieGogo. Small businesses trading equity for investment have also found success on sites like Crowdfunder, Fundable, EquityNet, EarlyShares, CrowdCube, and many, many more.
But crowdfunding is not without its drawbacks. Here are 7 good reasons why crowdfunding may not be right for your business:
1. Someone May Steal Your Idea
The whole idea behind crowdfunding is to get strangers excited about your business, product, or idea. But that also requires you to reveal your plans to the public, usually long before your product is actually ready, or firmly off the ground.
Although there are definitely ways to protect yourself (e.g., patents and copyrights), there’s no doubt that making your project public makes it easier for others to cop you, especially if your crowdfunding campaign ends up failing.
2. Crowdfunding Can Be Stressful
A crowdfunding campaign is more than just asking for money. It requires marketing, PR, and strategy. It requires being sure that you can deliver whatever you promise to your investors. It also comes with deadlines and the very real chance of failing if you set your goals too high. Combined with the other responsibilities of running a business, crowdfunding can wear your company out before it really even gets off the ground.
3. Crowdfunding Comes With Deadlines
Crowdfunding usually comes with two key deadlines: (1) raising enough money by the date you’ve set; and (2) delivering the product or idea by the date you’ve promised. Using a small number of key investors can avoid the stress of these deadlines. Unlike crowdfunding, traditional investors don’t usually invest on an “all or nothing” basis—you won’t lose everything if you don’t make your target by a specific date. And unlike crowdfunding, traditional investors may let you stretch your deadlines because they understand your business needs, whether that’s getting your product just right before retail or making sure your business is truly ready for launch. Thousands of strangers, by contrast, are less likely to be forgiving.
4. A Failed Campaign Can Kill Your Company
A good crowdfunding campaign involves marketing, PR, and social media. To get strangers to invest, you have to attract their attention first. Unfortunately, this also means that people will be acutely aware when your crowdfunding campaign fails. Those same people will be less likely to invest in your business again, and your business may also be less likely to attract other investors in the future.
5. Other Money Sources May Be Better
Put simply, sometimes it’s just easier to get a loan. A loan avoids most of the downsides on this list while getting you the funding you need. Of course, crowdfunding sometimes amounts to “free money,” and a loan is definitely not free. And some businesses simply can’t get bank loans. Nevertheless, your business may qualify for a syndicated-loan and, in any case, it’s worth looking into.
6. There Are Too Many Regulations
This downside applies to businesses who want to use crowdfunding to raise capital in exchange for equity. The JOBS Act, passed by congress in 2012, explicitly makes this legal, but also lays down some tough regulations. If you raise money through crowdfunding, for example, directors and senior management could be personally sued for violations of the Act. The Act also puts in place strict financial disclosure requirements. Although the SEC is still interpreting the law, its rules and regulations generally appear more onerous than the rules for businesses who sell equity using more traditional methods.
7. You May Lose Too Much Equity
Maybe you are only raising money for a product, and giving your investors some of that product in exchange for their investment. But very new businesses—or businesses without a product—usually must raise capital by giving away some ownership in the company. If you don’t structure your crowdfunding campaign carefully, you could end up giving out more equity than you intended. And in general, crowdfunding gets a worse equity-to-dollar ratio than you would get using traditional investors.
This is not to say that there is never a place for crowdfunding. Crowdfunding has helped thousands of successful businesses get off the ground. Being aware of these drawbacks, however, will help you understand whether crowdfunding is right for your business idea.
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