July 15, 2020

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by: Jonathan Hung

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Tags: angel investor, Startup Funding

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Categories: Startup Funding

Crowdfunding For Startups Part II: Is It A Good Fit For You?

Part II: Reasons Why Crowdfunding May Not Work for Your Startup

So, in Part 1 we looked at the 2 main types of crowdfunding platforms, what I call basic crowdfunding platforms and then equity crowdfunding platforms.

Basic platforms like Kickstarter are usually best for consumer products and manufacturing-based campaigns since you can offer a discount or even a “free” product to incentivize people to contribute to your campaign. They don’t get an equity position, but they will get a discount or just a trinket to show that they participated. These types of campaigns have been rife with scams as many campaigns can claim to be building an amazing product and then simply fail and simply pocket the money.

Equity crowdfunding is a lot more regulated by the SEC and holds the promise to let almost anyone participate in the startup ecosystem and take a chance at picking a winner.

Yet, neither of these types of platforms are easy to succeed at. It’s not a case of “post your campaign and ‘they’ will come”. There are many costs associated with creating a crowdfunding campaign for your startup that has the possibility of raising money.

However, there might be some reasons to consider why crowdfunding for your startup might not be right for you.

 

Table of Contents:

Part II: Reasons Why Crowdfunding May Not Work for Your Startup

  1. Basic Crowdfunding Doesn’t Raise a Lot Of Money
  2. Equity Crowdfunding Has a Lot of Regulations
  3. It’s Not Just About the Money
  4. Crowdfunding Campaigns Eat a Lot of Time and Energy
  5. You Want Networking and Connections
  6. Your Startup Will Need To Learn To Pitch To Investors Anyways

Conclusion

 

 

Under the right circumstances, crowdfunding can be beneficial for startups – especially those in their early stages. However, crowdfunding is not the ultimate solution to every capital problem. There are 6 reasons, in particular, why crowdfunding may not work for your startup!

1. Basic Crowdfunding Doesn’t Raise a Lot Of Money

Less than 30% of all projects on Kickstarter, a basic crowdfunding platform, raise over $10,000. Less than 15% of all projects raise more than $100,000.

Depending on the amount of money you need for your startup, crowdfunding may not be the way to go. The average startup probably needs more than $5,000 for the proper development of a prototype, legal filings, and so on. Additionally, once the campaign ends, if you haven’t met your funding goal, then typically the project terminates, and the backers receive all their money back (this varies, of course, by platform). There are no “subsequent” investing rounds, so to speak.

Traditional angel investors are almost always willing to invest more than $10,000. If you need more significant sums of money, then going through conventional investment channels still makes the most sense.

In addition, there are marketing cost associated with crowdfunding, especially with the basic crowdfunding platforms, that they don’t always tell you about. For example, on Indiegogo you can post your campaign, but the visibility of your campaign depends almost entirely on you. If your campaign is not showing “Momentum” then it does not percolate to the top page and does not get reviewed by the team at Indiegogo. The only way to get “momentum” is to drive a lot of people to your campaign page and get a lot of activity. The best way to do that is to advertise extensively. Sometimes the advertising costs can eat significantly into any funds you raise.

2. Equity Crowdfunding Has a Lot of Regulations

Of those startups that are successful at raising capital through equity crowdfunding, the average raise was approximately $263,000.

That sounds great, right? However, in 2019 only 2,187 campaigns were successful. In 2019 there were only 735 SEC Form C filings to take advantage of Reg CF. There were far more companies joining the top 8 crowdfunding Equity platforms that did not meet the requirements or could not complete the paperwork in time to file.

However, there are other reasons that equity crowdfunding campaigns can fail or even fail to launch. For equity crowdfunding sites, besides paying a fee to join the cohort, you will need to create a slick campaign, usually a video that potential investors can view and hopefully get impressed enough to ask for a meeting. Creating these campaigns can be costly unless you happen to have all the equipment and software, as well as, the editing skill to put it all together.

 

3. It’s Not Just About the Money

One of the critical factors that are missing when you decide to utilize crowdfunding rather than an angel investor or a VC is the experience and guidance you get form professional investors.

Once a serious investor makes a decision to back your startup they want it to succeed. So you can usually rely on them to give you the benefit of their expertise and experience in operations, marketing, and product development. These are not typically the benefits that you see when you crowdfund your startup even in an equity crowdfunding situation.

Usually, people who invest in startups are people with success in the industry. They have significant connections, and they have a keen passion for helping companies grow. Remember, your success is their success! As such, when an angel investor wants a seat on the board, they will also bring significant expertise with it.

That experience, from a seasoned investor, is often invaluable for avoiding early mistakes. That investor has likely seen it all. They’ve seen companies make mistakes and recover. On the opposite end, they’ve seen companies crash and burn after similar mistakes. With their expertise, you’ll receive that experience and, hopefully, make decisions that will ensure the continued growth of your startup.

4. Crowdfunding Campaigns Eat a Lot of Time and Energy

Crowdfunding for startups takes time. Time and energy your team could be used to build a better product, get customer feedback, and network with angel investors.

There’s a significant amount of time, energy, and money that you will spend creating the campaign, marketing it, and driving traffic to it to invest. The “novelty” of crowdfunding has worn off, and now people need to advertise their efforts effectively to see significant results (unless, of course, you already have a significant social media or celebrity following).

To see significant returns, some aspiring enterprises have to spend as much as 50% of the amount they raise on marketing. You might have to pay $25,000, for example, to receive a $50,000 round (which, as we discussed earlier, very few companies achieve $50k). Of course, there’s also the possibility that the entire endeavor might backfire, and you wind up losing money during the critical initial stages of your business.

All that marketing money and time will eat into your ability to develop the product further. Most experts say that the most successful crowdfunding campaigns will take 11 days to prepare and will last for nine weeks until closing. These statistics mean that you will wind up taking about three months from start to finish to raise the capital.

Depending on your product, contacts, and so on, it can sometimes be faster and more straightforward to get a meeting with an angel investor. Raising funds this way can usually free up your business to focus on the product and initial operations as opposed to a crowdfunding campaign.

5. You Want Networking and Connections

Unfortunately, creating a crowdfunding campaign does nothing to help your networking and connections. You’ll do some research for a few days, put your campaign online, and then start marketing until the campaign closes.

When you go with more traditional investors, they can often help you in ways above and beyond the bottom line. These professional investors can introduce you to meaningful connections that will help your business succeed. They can also usually assist with providing a platform to market your product and get it into the hands of customers.

While crowdfunding for startups has the potential to get your business the money it needs, it seldom has the potential to open many doors above and beyond that.

6. Your Startup Will Need To Learn To Pitch To Investors Anyways

Crowdfunding alone will never net you enough money to take you to the IPO stage. If you’re thinking big, then you’re eventually going to need to pitch your business to investors in the Series A, B, and C rounds. Pitching your company to angel investors and other VC firms is a way to learn how to navigate those waters successfully before you start those rounds. Of course, that’s not to say that by crowdfunding, you will not be able to have a series A round of funding – it can and does happen – but you might not learn some of the skills it takes to be successful in pitching to professional investors for those funding rounds.

In addition, funding from angels or VCs at the seed stage is a signal to other potential investors in future rounds that your startup is worthy. Investors tend to act almost like they travel in herds. If one investor shows interest or better yet invests in your round then other investors start to take notice.

Conclusion

As we have seen, there are many pros and cons to crowdfunding for startups. On the one hand, the basic form of crowdfunding is accessible, convenient, and relatively “easy” to put a listing on a popular crowdfunding site and market it. You might not reach your goal, but you won’t necessarily be penalized (except in wasted marketing dollars) for at least attempting it. On the other hand, it also doesn’t seem like a significant ROI. When you think of all the time, effort, and money to do the campaign right, the fact that 70% of these campaigns raise less than $10,000 is discouraging.

For equity crowdfunding, there are some additional steps to stay in the good graces of the SEC and not screw up your offering. Equity crowdfunding for your startup can be a great solution for you under certain circumstances but don’t ever think that you won’t need some slick marketing materials to catch potential investor’s attention and “ sell” them on your startup.

Typically, crowdfunding works in limited scenarios, where companies have a strong following already, or they are merely using crowdfunding to top off a round that has fallen short from more traditional methods. Your startup may wish to consider the pros and cons carefully before engaging in a crowdfunding campaign.

 

Jonathan hung, Angel InvestorAbout the Author:

Jonathan Hung is One of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.

Jonathan and his team target investments in US companies that have global market potential with a focus on long-term growth expansion to East Asian markets.

Jonathan developed his investing prowess as a Managing Member for his family office fund, J Heart Ventures, which made investments in start-up companies such as Gyft, ChowNow, Miso Robotics, Clover Health, Bitmain, to name a few startups he funded.

Jonathan has various degrees from the University of Southern California, London School of Economics, Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.