Should You Use Crowdfunding To Finance Your Business?

Chances are, you have tried to find the best options for financing your eCommerce business. Then you landed on crowdfunding. It sounded like a great idea – strangers give you money without promise of repayment or interest. We have seen crowdfunding success stories from Kickstarter and GoFundMe, so why not give it a try? By all means, we encourage you to do what is best for your business, but in this article we want to explain why crowdfunding might not be the ideal choice for every eCommerce Business. 

What is Crowdfunding?

In reality, crowdfunding is actually a bit more complicated than just receiving money from strangers – if that were the case, we would all be able to hop on there and finance our wildest dreams. 

Crowdfunding means receiving multiple small donations from many investors. There are four types of crowdfunding, and each has their own rules/regulations:

1. Rewards
2. Donation
3. Equity
4. Debt

Rewards

You might be familiar with reward crowdfunding if you have ever donated or used KickStarter. Reward crowdfunding is exactly how it sounds – you ask for money and you give a tiered based reward for the amounts donated. You set up the parameters at the beginning of your campaign (ex. if you get $10 you need to give a pen with the company logo, etc) and as the donations increase, the value of the rewards increases as well (ex. for $500 donated you will need to give a free product and a pen with the company logo).

Donation

When you give to Goodwill or the Salvation Army, you don’t expect anything in return. It’s the same with donation crowdfunding. In this instance, you would do the same in donation crowdfunding. People would give out of the goodness of their own hearts and you collect without any type of repayment. 

This is a great idea, but you have to find a lot of small investors who are willing to give their money away with no return. Donation crowdfunding can be very difficult when you are trying to reach a goal. 

Equity

Unlike donation crowdfunding, equity crowdfunding does offer a return to your investors. Think of the people who give you money as smaller venture capitalists. You are actually selling a part or shares of your company to multiple investors in order to raise capital.

Essentially the “reward” for the investors is that they share your profits and losses. Whatever percentage or amount of shares you offer to them, that is how much you will have to pay out from your profits in order to continue using their investment. This decreases your end-profit margin so there is less equity in your business. 

Debt

If you are thinking that traditional loans are not for you, then don’t consider debt crowdfunding. Debt crowdfunding is essentially a loan, except you are required to pay back multiple small loans from a variety of lenders. These lenders not only expect repayment, but they expect interest as well. 

The interest rates can vary as well. So think about it – instead of one lump sum loan, you have a bunch of small loans from different lenders with different terms/interest rates. All of that would be incredibly hard to keep track. 

Drawbacks of Crowdfunding

The different types of crowdfunding offer an option for almost every business. Generally, these types of financing are used by startups in an effort to get their business off the ground floor. More established small-businesses can certainly try crowdfunding as well, but it will be more difficult to attract donors. 

Crowdfunding platforms have their own rules and policies, but generally speaking, most of them will require a fee. Whether it is a flat fee or a percentage of what you raised depends on the platform. There is potential for added/hidden charges as well, such as a flat fee per donation (which can add up quickly), or fees for not meeting your goal. 

Speaking of not meeting your goal, it’s common for crowdfunding platforms to state that if you do not reach your fundraising goal, all of the money reverts back to the donors/investors. That means you spent all that time, raised a few donations, and paid fees to have nothing to show for it. 

Alternatives to Crowdfunding

Frankly, crowdfunding is great for some businesses, but most will not generate enough capital in order to grow and expand. If you are die-hard about giving it a try, no one here is going to stop you. We will, however, provide you with a few alternatives in case you believe that crowdfunding is not your ideal financing option. 

Merchant Cash Advance

Merchant cash advance is a fairly common choice for eCommerce businesses. The MCA lender gives you the capital you need up front, and you make repayments based on a percentage of your debit/credit card and online transactions. The payments are automatically withdrawn, usually on a daily basis through an account set up with an approved credit card processor. 

Revenue Share

Revenue share financing, or revenue-based financing, is a flexible financing option based on your revenue. Like merchant cash advance, revenue share financing allows you to pay back in variable amounts instead of a fixed monthly payment. When you receive the capital, repayment is made based on a percentage of your revenue. So, in theory, you could repay $1000 one month and $250 the next. You don’t have to stress about having a slow month because it entirely depends on your monthly revenue. 

Invoice Financing

eCommerce businesses that send their customers invoices instead of expecting immediate payment can benefit from invoice financing. Essentially, you use your unpaid, but credible, invoices as collateral against borrowing capital. Once the invoices are paid by the customer, you can repay your loan. If you are unable to repay the loan, the financing company will secure the invoices and collect on them. If the customer does not pay the invoice, you are still responsible for the balance. 

Conclusion

Crowdfunding is a can be a great option for startups, but not every business that uses this method will be successful. It can be a “roll of the dice” which fundraisers receive funding and which ones are passed over. For a better chance at financing your business, we recommend checking out all of your options and finding which one works for you.