SA Crowdfunding Blog

Monday, 11 June 2012 21:12

Crowdfunding as a Business Finance Option - 4 Key Considerations

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A cattle farmer in Southern Limpopo utilizes crowdfunding to aid in pre-selling his beef. He has found it to be a way to re-grow his herd after the mad cow epidemic. This is just one indicator why business finance is morphing from the old ways to more creative ones.

At one time, crowdfunding was simply a vehicle for movie makers or artists to fund their projects, and then as if a revelation occurred, the trend caught on and many others began to seek project funding in this way.

A positive result to come from global economic woes is the general understanding that banks aren't as powerful as people once thought they were. Many big names in finance are no more, and it is evident that changes in banking have only made it more difficult to arrange loans with the remaining institutions.

Business finance through banks has always operated under the concept that the person with money was the only one who could borrow money. There was a phase when the lenders were more lenient with credit and looked the other way regarding some business finance situations that were questionable. Those days are in the past and it is unlikely that they will return.

The difficulty in finding business finance is not just for start up companies either. Well established businesses are finding it harder to arrange loans for expansion or maintenance. To keep the wheels of commerce turning, crowdfunding is the best option in many cases.

How crowdfunding takes place depends on several factors. These items need to be clearly defined before attempting a successful business finance campaign:

1. How Much Capital is Needed
While it is best never to seek more than you will need, it is also better only to ask for funding the one time to avoid losing credibility. There are numerous models you can use showing you how to estimate what you need in business finance, but including the known, estimated, and adding a percentage for contingency should provide a fairly accurate number.

The amount of contingency should be reasonable in regards to the number of "unknowns" in the venture.

The amount of capital needed has a great bearing on how crowdfunding is addressed. If your needs are only a few thousand dollars, a locally based campaign is probably the best way to go, but for hundreds of thousands of dollars, your base will need to extend farther and your preparations will be more involved.

The higher the funding need, the more investors there will be who do not have a personal relationship with you, and they will need more information before they are willing to provide their support.

2. How Investors Will be Compensated
In most cases, investors crowdfund because there is opportunity for a much better return on their money than in stocks or other more traditional investments. From your standpoint, you need the money, but don't want to give away everything you gain from its use. This is one reason why it is better to have an experienced professional handle a business finance project.

Some business finance models are leaning more toward licenses for investors rather than business owners giving up equity. This works with a new product that has the potential of a major market share.

Investors receive the license for set geographical areas so they receive profit from the retail sales there. Larger cities would, in concept, cost investors more than the smaller markets because there is a potential for more sales.

A pro forma may not be necessary in a crowdfund, but investors need to feel they have good odds of getting a substantial return on their money. The return doesn't have to be in company shares or a percentage of the profits, but it must be attractive enough to garner interest. Returning investors will have some concept of what they desire in return, and this is a good reason to seek advice on how the campaign should run.

3. What is the End Target Market
Based on the product or service your company provides, the crowdfund may come from either a limited pool or a universal one. Solicitation of funding is much different for a business that caters to all ages, sexes, and cultural areas than for one that focuses on a small niche in the market. In some cases, a niche market is more attractive to investors than a broader one, based on the amount of competition.

Some offerings do better than others in business finance solely because their expected success is heightened by public opinion and current social or political opinions. An existing business in need of funds might need to introduce something new that expands its target market to attract business finance through a crowdfund.

4. How Sellable is the Business
The first conception of crowdfunding was that many of the campaigns were for hair-brained schemes, the consensus being that it was the only reason why anyone would have to do business finance that way.

Of course, the short history of crowdfunding has shown this was wrong and many ventures have produced very well for investors and allowed companies a chance they might not have had otherwise.

Investors are smart enough to weigh risk and reward and make decisions on their investments. Few, if any, investments in business finance have assured outcomes, but a company with a good track record and a great product has a better chance of raising funds than one with no history or a product that might not prove to be successful.

What the Future Holds for Business Finance through Crowdfunding
An internet site that tracks the progress of crowdfunding reported that more that $1.5 billion was accumulated through 450 internet sites worldwide in 2011. Projections of twice that for 2012 are not that hard to believe. The power of the internet is that it can hook up the right investors with the right opportunities faster than could have possibly happened before it came into the picture.

Investor confidence has grown in crowdfunding because of the success others have had. The limited returns for savings and losses from stocks have made crowd source funding the better choice in the investment market, and business finance is encouraged to evolve to this source in anticipation of more jobs being created as a result.

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