Crowdfunding has been growing in popularity as an alternative to business loans to fund new products and projects. Let’s look at how crowdfunding works, the challenges involved, whether it could be right for your business, and how it differs from crowd-sourced funding.
What is crowdfunding?
If you have a small business, getting funding can be a challenge. One option when you aren’t making progress getting business loans is crowdfunding.
Crowdfunding is simply a way to fund a business venture or project by getting small investments from many people in return for one of your products (when it has been produced). It’s popular with artists and entrepreneurs when they are looking to finance a new product or idea. The good thing about crowdfunding is that you can test if the market is interested in your offering before you invest a lot of time and money developing it.
Many crowdfunding websites exist where you can make your pitch about your product or idea to raise the funds to make it a reality. When the amount of funds you require is raised, the crowdfunding platform will release the funds to you.
From the beginning, you will want to be very clear about how much money you will need to create the product that you will send to your funders. The challenge with crowdfunding is getting enough people interested in your idea to raise the money you need. Marketing efforts for crowdfunding usually include creating a compelling video and being active on social media.
The difference between crowdfunding and bank business loans
For a clearer understanding of crowdfunding and if it’s right choice for you, we’ll look at the main differences between these finance options.
Source of funds
With business loans, the bank provides the funds if your application is approved.
Using crowdfunding, the platform hosting your campaign provides the funds that have been pledged by people or groups.
Application and approval
For business loans, a bank will review the information you provided. This will usually include your financial statements, credit scores, business plan, tax return and other documents. The approval process for bank business loans can take 60 to 90 days from start to finish.
With crowdfunding, the process of getting your campaign approved is typically faster than getting bank loan approval but this will depend on the requirements and guidelines of the platform you choose. Once your campaign is approved, you can start raising funds. However, there is no guarantee that you will reach your required funding amount.
Getting bank business loans will typically require having good business and personal credit scores.
No credit scores are required for setting up a crowdfunding campaign.
With bank business loans, you need to make payments which include principal and interest, based on agreed intervals until the loan is paid off. Fees and penalties are charged for late payments or defaults. Your assets can also be at risk if you fail to repay the loan.
You don’t need to repay the funds raised through your crowdfunding campaign, but you are required to deliver what you have promised for the funds pledged.
Crowdfunding pros and cons
The challenge of crowdfunding is getting enough individual investors or groups to support your idea. If you already have a fanbase for your product, you will have a head start. You can get feedback through social media and other channels where your potential buyers are found.
A large part of crowdfunding is having an enticing marketing campaign. This usually includes a short video that shows how great your idea is, and it can be quite expensive to create a professional and enticing video. Besides effective marketing, you will also have administrative responsibilities including communicating with your ‘investors’. In general, crowdfunding is good for artists and entrepreneurs who have a one-off project to develop a product or concept.
Pros and cons of bank business loans
Typical business loans from a bank require a lengthy and strict application process with no guarantee that you will get the loan. In fact, banks reject around 75% of business loan applications from small businesses in Australia. With a bank business loan, however, your only obligation is to pay back the loan as agreed, so you don’t have to deliver your product to your funders.
Know the difference between crowdfunding and crowd-sourced funding
In general, the term ‘crowd-sourced funding’ applies when a business is raising equity through an online platform. In contrast, ‘crowdfunding’ is raising funds where the ‘investor’ gets a product in return.
Crowd-sourced funding in Australia
In Australia, crowd-sourced funding makes it possible to invest up to $10,000 per year in an SME seeking funds to grow or pay off debts. In exchange, the investors receive shares in the business. This form of equity funding has been regulated by the Australian Government since September 2017. There are several restrictions on how you can raise funds using crowd-sourced funding:
- It’s only available to public unlisted businesses that have less than $25 million in assets and annual revenue.
- Each investor can only invest up to $10,000 in a 12-month period.
- The operator of the crowd-sourced funding website must have an Australian Financial Service (AFS) licence.
- Investors have a cooling-off period of five business days if they decide the investment isn’t for them.
Whatever option you choose – business loans, crowdfunding or crowd-sourced funding – be sure to weigh all the positives and negatives. It’s also a good idea to seek advice from an accountant or other business finance expert.
You also could consider an unsecured business loan from Moula as a way to meet your business finance needs.
For comprehensive information on business loans, get The Complete Guide to Business Loans in Australia.
If you would like an estimate of principal, interest and repayments for a business loan, check out our business loan calculator.