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Why do many businesses choose to crowd fund?

by PlanWriter | on January 18th, 2015

Since the economic downturn that developed from 2008, new businesses have found it hard to raise initial start-up capital from traditional methods such as bank loans and traditional investment. Alternative ways of funding a new business venture had to be found, and an increasingly popular way of raising this capital is through crowdfunding. These new forms of credit seem to be growing in popularity amongst new businesses, as well as those businesses that are more established. Rather than applying to a well-known bank, there is an increasing tendency of businesses using crowdfunding; this may start to dramatically change the financial sector in future years.

What is crowdfunding?

Crowdfunding involves many individuals loaning small amounts of money to a business, typically via the Internet. The number of crowdfunding platforms has increased significantly since first being established online around the middle to late noughties. This method of raising capital is now thought to account for the lending of billions of pounds to businesses worldwide. The concept is similar to the cooperative movements in recent history and these systems were devised and developed by collective groups and like-minded individuals to enable the progress of new concepts and products. Some extended families traditionally help other family members to set up their own businesses through financial help and support. However, whichever way you look for funding writing a business plan is essential to convince anyone to invest in a business, corwdfunded or not.

There are several types of crowdfunding which new business owners could consider, including loaning money that is then repaid with interest or exchanging a percentage of the business for equity. The business may also be looking to the crowdfunding to provide additional support, such as using the investors in a mentoring capacity, as well as a source of funding. This is something that a traditional financial institution would not offer in addition to the money and since many new business owners are inexperienced, this can offer them more of a chance of survival.

The advantages of crowdfunding

An advantage of crowdfunding to a new business is that the capital is already available and waiting for the right opportunity to be presented. Banks began to restrict their lending to business in the wake of the financial crisis and especially to new businesses, which are deemed to be very risky. Even if the new business already has a business bank account with some funds in it, and a solid business plan written they may find it difficult to obtain a traditional overdraft on the account as a source of extra funds. An overdraft can only be taken out with the bank with which the business holds its current account and there is limited choice when searching for possibilities. In addition, even if the business has an overdraft it can be retracted at any point and the funds asked to be returned. If this happens early on in the new business it may be enough to ruin the enterprise.

In addition, the crowdfunded finance can often be raised in a short amount of time and often there are not any other upfront fees which may be associated with other forms of funding. However, this form of investment still needs a thorough and well though-out business plan, as well as financial forecasts for the business going forward. The new business will have to convince many people of its potential and viability in order to attract the necessary funding required, so it is not a short cut to getting someone to part with their cash.

Another advantage of using a crowdfunding platform can often raise awareness of a company before it is launched. The new business is fully explained to potential investors and they will often have the opportunity to ask questions about the new proposal. As the investors get to know the opportunity they may decide to invest in the business because they are interested in the product which the company will be offering. This may provide an initial customer base for the new business to begin trading and also act as an additional form of market research as to whether people think the new start-up is a good idea and a workable business.

Lowering the risk

New businesses that are seeking funding from a traditional investor often have to go through a time-consuming and demanding process. Only limited companies can sell shares in their company so if the company is a sole-trader or partnership then this method cannot be used. Even if the new business is a limited company it probably doesn’t have enough information to allow an investor to adequately weigh up the opportunity being presented. Early stage businesses are often much more high risk ventures for individual backers. Many investors may want a proven track record for the business, a well-presented business plan and demonstration of the demand before parting with their cash. Crowdfunded investors are often only risking small amounts of cash and therefore may be more open to risk-taking and being involved in a new business earlier on in its development.

Using personal loans to fund the new business can be very risky for the new business owner. The loan may be secured against personal assets such as a house and these maybe at risk if the business goes under. Using personal credit cards as a source of funds could also leave the business owner in a very compromised position if the business goes under. Crowdfunded finance is provided to the business although they may want to know you are willing to invest your own money in the new business; this is less risky than potentially running up huge personal debts or losing the roof over your head.

As with all new business start-ups many there is a risk that the business does not work out. Using crowdfunding spreads the risk across many people, so if the worst does happen then there is not just one person to shoulder the burden. Many of the investors will be protective of their cash and very keen to find out as much about the new business as possible. The right detailed research and thorough preparation is essential for any new start-up and a crowdfunded business is no different.