Taking money from strangers

Many of my clients are business owners who want to grow their businesses. To do this they need capital to pay for things like additional staff, larger offices or more product. And to get this capital, they usually need to apply for a bank loan, ask relatives or, for a select few, attract angel investors or venture capital.

But with the internet in full bloom, we now have access to thousands of people worldwide. This has allowed a financing phenomenon to take shape known as crowdfunding and is brought to you by such websites as Kickstarter, Indiegogo and Peerbackers.

Need funding to bring your latest invention to market or to open a second location for your popular pizza parlor? Rather than go to the bank, you can now ask a bunch of strangers to send you money…and many of them will.

Crowdfunding is different from traditional sources of funding in several ways. Typically the projects or ideas funded through the internet have a clear beginning and end, such as writing a book, producing a film or marketing a gadget. And now you can even ask for help paying for some of your medical expenses.

Contribution levels in crowdfunding begin at $5 and can attract literally thousands of “investors” willing to give you money and yet expect little in return besides maybe a t-shirt or mention on your website. The payback for them is often just the warm glow of having invested in what they view as a really neat idea, product or cause.

Venture capitalists and private investors, by contrast, provide large sums of money: $1 million to $50+ million to fund high-risk ventures that do not necessarily have a clear beginning or end. With this type of investment, there is a distinct possibility that you will lose your entire investment – or make millions. Just ask a few VCs in Silicon Valley. These professionals, in return for their investment, expect a percentage of ownership in your venture as well as a seat on the board of directors or a significant management position.

So let’s review how crowdfunding works:

Let’s say you have a neat idea for a watchband that lets you strap an iPod Nano to your wrist. You need a few hundred thousand dollars to bring this product to market – but you know it’s a great idea and will sell well. You also know that VCs are not interested in this kind of venture, so you consider crowdfunding. Your first step is to choose the crowdfunding website that is most appropriate for your business. There are now over 150 such sites, three of which I mentioned above with links. For our example we’ll choose Kickstarter.

Your next steps:

  • Establish a realistic funding goal and time period, say $250,000 to be raised within six months.
  • Describe your invention/project/idea in a way that will compel total strangers (as well as friends and relatives) to send you pledges. This, to me, seems like the most important step to do very well.

To your amazement, pledges start rolling in from people all over the world in amounts ranging from $5 to $1,000. You reach your funding goal – and then SURPASS it. Within six months, lo and behold, you’ve raised $942,578.

But this is not a made-up example. This is exactly what happened to TikTok and LunaTik (love the name) who set a record for pledges on Kickstarter in 2010. Since that time, several companies have raised millions on crowdfunding sites.

So, what’s the revenue model for these sites? Kickstarter takes a 5 percent commission from every project that reaches its funding goal – and amazingly, 44 percent of submitted ideas meet or exceed their funding goals.

Let’s step back for a minute. In my view, this is a quintessentially American idea – so creative, so “out there.” And the concept is guaranteed to grow and mature because in April of this year, President Obama signed the JOBS (Jumping Our Business Startups) Act, which relaxes securities regulations in the interest of encouraging crowdfunding investment in companies of all sorts.

My advice to clients? Start researching crowdfunding sites now; write out your idea; set a funding goal and see what happens. This is a funding source definitely worth considering.

Categories: Finance