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Crowdfunding is just one of many ways of financing a
business venture or a project. Like all other methods, crowdfunding has its
advantages and disadvantages. Below I discuss some pros and cons of raising
money through a donation-based crowdfunding platform.
In my opinion, the main and unique advantage of crowdfunding is that people who
are raising capital through crowdfunding (I will refer to them as
entrepreneurs) can also use it as a marketing tool. Publishing information
about a product or a project with a goal of raising capital on a well-read
crowdfunding platform also raises product or brand awareness. Crowdfunding is
not just limited to one single website. Supporters of the project disseminate
the information using their social networks and encourage people in their
networks to do the same.
Also, in addition to the money, entrepreneurs often get feedback. What can be
better than "beta testing" your product and simultaneously raising capital for
it? If the project does not reach the funding goal, this may be a signal to the
entrepreneur that the market is not responding favorably to the offering and
perhaps a change is in order. Of course, it is possible that the crowdfunding
crowd is not the intended market for the product, hence the limited response.
So, entrepreneurs should listen carefully to the market signals they receive
through crowdfunding feedback and respond appropriately.
Another advantage of crowdfunding is that entrepreneurs can raise capital
without giving away any equity. It is just like receiving a gift or a donation
that you get to spend on your favorite project.
Finally, raising money through a donation-based crowdfunding platform is
relatively inexpensive (especially given the fact that entrepreneurs do not
need to give up equity). There is usually no need to engage lawyers or other
advisors to assist in the process. Most sites charge a fee equal to about 5%
fee of the money raised and another 3-5% in processing fees. Entrepreneurs also
need to pay taxes on the raised capital (that would be income to the
entrepreneur) and send out gifts or rewards that entrepreneurs are expected to
give to their donors.
The main disadvantage of raising capital through crowdfunding is that
entrepreneurs may be limited in the amount of money they can raise. An average
raise amount is between $2,000 to $10,000. This may be enough money for a small
project but not for a sizable venture. The reason is simple: people are
reluctant to give money if they do not get any return on their investment. This
is reasonable, and should be factored into the initial calculation.
Another disadvantage of using crowdfunding as a means of raising capital is the
fact that your business idea would be exposed to the whole wide social network
and there is no guarantee that someone will not decide to implement it. You
cannot sign a confidentiality agreement with the internet.
There are risks for the donors as well. The crowdfunding sites may conduct a
preliminary check to ensure the business is legitimate, but it is unlikely that
they will be held responsible if it turns out otherwise. Also, the sites
usually do not enforce allocation of the funds or that supporters receive their
promised gifts. What happens to the project that is only partially funded? Some
crowdfunding platforms would still release the money to the entrepreneurs.
However, there may not be enough funds to launch the project originally
contemplated, which begs a question of how and for what purpose this money
would be used then. In my opinion, lack of accountability may present a serious
problem as the number of participants on crowdfunding sites increases
proportionately to the likelihood of occurrence of fraud. This may serve as a
potential deterrent for donors as well as expose the crowdfunding platforms to
In the next post, I will talk about the ideal candidates for using crowdfunding
to finance their businesses or ideas.
Read more commentary from Arina Shulga on the
legal aspects of operating new and growing businesses at Business Law Post.
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