There has never been a better time in history to start a business. Founders now have more options than ever before when it comes to acquiring capital. Crowdfunding platforms like Kickstarter, Indiegogo, and GoFundMe have made funding more attainable. In fact, the total amount of money raised via crowdfunding reached $738.9 million in 2016.
"Crowdfunding has garnered a lot of popularity, not only for the ease of setting it up with today’s technology but also because of the success rate," says Business.com contributor Larry Alton. "It is one of the biggest tactics small businesses can use to get their business off the ground running and there are several factors that contribute to that success."
Pebble, a smartwatch manufacturer, raised more than $10 million from 7,841 backers in 2015. It was the most highly-funded crowdfunding campaign of all time.
However, private investment still reigns as the ideal financing option for many startups. According to a report released by PitchBook and the National Venture Capital Association (NVCA), more venture capital was deployed into the startup ecosystem last year than any other time period since the dot-com era. A whopping $84 billion was invested across 8,076 deals in 2017, $46 billion of which was distributed in the fourth quarter.
So, which is the better route for your startup: Private investment or crowdfunding?
Private Investment vs. Crowdfunding: Which is Better for Startups?
Private Investment
The startups that have the most to gain from private investment have already achieved product-market fit. In most instances, these startups are ready to scale fast. Experienced investors can provide the directional insight early-stage startups need to unlock accelerated growth.
Investors can also provide later-stage startups with the growth capital they need to hire more team members, expand into untapped markets, and develop new product ideas.
Here are the pros and cons of private investment:
Pros:
- Guidance: Investors have the insight, knowledge, and experience to help you navigate common roadblocks. More than just financiers, the best investors also act as consultants. With plenty of skin in the game, they are substantially motivated to pick up the phone, answer any questions, and provide advice.
- Greater Investment: Top VCs invest close to one million in early-stage startups and substantially more in later-stage ventures. The more money you have at your disposal, the faster you can move forward.
- Less Risk: In many ways, accepting venture capital means lowering your risk. VC and angel investors are gambling on your startup and accept the possibility of a loss. Unlike traditional bank loans, venture capital investments do not come with legal requirements for repayment. If your company fails to take off, you will not be saddled with a huge burden of debt.
- Connections: Partnering with a successful VC means having access to his or her professional network including manufacturers, lawyers, reporters, and more.
Startups can achieve accelerated growth with the right fundraising strategies in place. Learn how in the Startup Unicorn Checklist.
Cons:
- Less Control: The most obvious downside to accepting venture capital is giving up a percentage of your equity. The more shares you relinquish, the less control you have over your startup. For this reason, it is imperative that founders thoroughly evaluate investors before forging partnerships. Does this person have experience in your vertical? Do he or she understand your vision? Is he or she someone you can trust? Answer these questions carefully before cutting a deal.
- Greater Pressure: Startups must achieve product-market fit and perfect business models before seeking investment. Without those components, startups will face difficulties delivering a ROI. That pressure often translates into poor hiring decisions, incorrect assumptions, and rushed decision-making. Premature scaling is the primary reason startups fail.
- Minority Ownership Status. The more rounds of funding you raise, the more equity you are expected to give up. Acquire too much cash too soon, and you may dilute yourself beyond 50 percent later on.
- Laborious Process: Compared to crowdfunding, fundraising requires a significant amount of time, energy, and perseverance. Most founders spend months perfecting their pitch, networking for contacts, and scheduling several follow-up meetings to procure investment.
Crowdfunding:
According to research firm Massolution, crowdfunding may soon overtake venture capital as the main funding source for startups. Crowdfunding is the ideal option for startups wanting to validate, test, and refine early product variations. Once a company can prove it knows exactly what consumers want, it is in a prime position to approach investors for early-stage funds.
“The largest challenge entrepreneurs face generally while raising capital is what I like to call the ‘lead investor game,'" says Ryan Feit, cofounder and CEO of SeedInvest. "It is a chicken and egg problem in which dozens of individual angel investors and even small venture funds express interest in investing, but ask the entrepreneur to come back to them when they have an investor who is leading the round [of funding].”
Unfortunately, it's not unusual for an early-stage startup to sit on hundreds of thousands of dollars in "commitments" without a lead investor. In 2012, crowdfunding emerged as a potential solution with the passing of the JOBS Act, which allows regular Americans to invest in startups.
Since that time, a variety of platforms have emerged, providing entrepreneurs with more funding options. Startups can now benefit from three types of crowdfunding:
- Rewards-based Crowdfunding (Kickstarter): Backers contribute small amounts of money — typically between $1 and $1,000 — in exchange for a reward.
- Equity-based Crowdfunding (AngelList): Investors give larger amounts of money in exchange for a small piece of equity in the startup.
- Debt-based Crowdfunding (Lending Club): Lenders provide money — similar to a bank — with the expectation of getting paid back the principal plus interest. The difference is the startup is now borrowing money in smaller amounts of money from multiple people.
Here are the pros and cons of crowdfunding:
Pros:
- Product Validation: One of the most challenging tasks faced by any early-stage entrepreneur is validating initial ideas. Developing a minimum viable product without significant capital in place can delay progress; crowdfunding removes that hurdle.
- Publicity: If your product idea is original enough, and your pitch is good enough, your crowdfunding campaign just may go viral. Third-party platforms like Kickstarter make it easy for backers to share the campaigns they are excited about. Participants are motivated to spread the word since their receipt of the product or service depends on the campaign's success.
- User-friendly: Crowdfunding providers make campaign creation easy. You do not need any HTML knowledge to create a page, initiate a campaign, and track your results. The hardest part will probably be making and editing a compelling campaign video for the page.
- Zero Equity Requirements (rewards-based and debt-based only): The biggest benefit provided by crowdfunding is that founders get to keep 100 percent of their equity. The earlier the startup stage, the more important guarding equity becomes.
Cons:
- Difficult for B2B: Rewards-based platforms are still more popular than the newer equity and debt types of platforms. Additionally, rewards platforms best lend themselves to consumer products. Had Slack decided to crowdfund its popular enterprise messaging app, it is unlikely the campaign would have generated much buzz. Why? Because backing a campaign is a personal decision, not a business decision.
- Marketing Challenges: Without exception, executing a successful crowdfunding campaign requires excellent marketing skills. Whether you are using a third-party platform, or hosting the campaign on your own site, you will be responsible for generating traffic to the page. Someone on your team must have experience with paid traffic acquisition, landing page design, and copywriting.
- Funding Rules: Most crowdfunding platforms require businesses to set a specific fundraising goal. In the event that the business does not acquire enough backers to reach its goal, it will relinquish all pledged financing. However, should you host a campaign on your own site with a plugin like IgnitionDeck, you can set your own rules.
Private Investment vs. Crowdfunding
Both private investment and crowdfunding provide startup founders with distinct advantages and disadvantages. Generally speaking, early-stage companies still validating ideas have the most to benefit from crowdfunding. Conversely, startups seeking entrepreneurial guidance, insider contacts, and support in scaling fast can profit from venture capital.
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