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The pros and cons of crowdfunding your startup

Posted: August 17, 20225 min read

Crowdfunding is among the most popular means of raising capital for all types of businesses. It's also extremely successful, with crowdfunding generating $17.2 billion every year in North America alone.

While crowdfunding might seem like the ideal way to get your startup off the ground, you need to understand what it entails. Here we'll go over what crowdfunding is, what sets it apart from other sources of funding, and the benefits and disadvantages that come with it.

What is crowdfunding?

Crowdfunding is a method of raising funds for individuals or businesses, whether to help kickstart a new business, complete a specific project, or support a cause. Normally, crowdfunding involves a large number of individuals who each donate a small amount of money over a brief period to meet a funding goal. Crowdfunding takes place both offline and online and often goes through various social media platforms to attract donors.

There are two primary models of crowdfunding: donation-based crowdfunding and investment crowdfunding.

Donation-based crowdfunding

In donation-based crowdfunding, donors will send money to help fund a particular project, which could involve a new product or service offering. The funds raised during this campaign would contribute toward the development of this offering. If a campaign involves a charitable cause, donors may receive certain other benefits in place of an offering. These benefits could include everything from a thank-you note from the recipient and name mentions in videos to personalized videos and certain perks.

Investment crowdfunding

These crowdfunding campaigns involve businesses that essentially convert donors into shareholders as they donate. This allows for a financial return that individuals wouldn't see with the donation-based model. Typically, this model of crowdfunding requests donations from accredited investors. Startups often use this method to get funding from a large number of investors when other fundraising options aren't as accessible or affordable.

What makes crowdfunding different from traditional funding methods?

Crowdfunding differs from other types of funding methods in a few key ways. Some traditional methods could include venture capitalists, angel investors, and loans from banks and other financial institutions. The following are the main differences between these methods and crowdfunding:

The potential role of equity

Equity in a startup is the money that shareholders normally receive following the liquidation of a business's assets and the paying off of loans and debts. Traditionally, angel investors and venture capitalists want equity in return for funding, which gives them a degree of control over the company.

However, through donation-based crowdfunding, startups have the ability to keep all of their equity, with investors receiving neither stake in the company nor direct financial returns. While investment crowdfunding gives equity to investors like other fundraising channels, you can use donation-based crowdfunding to offer other rewards to investors.

The level of risk

Getting funding through venture capitalists and angel investors comes with a degree of risk for investors. Although investors may gain a degree of revenue if the startup excels, they could experience more severe financial losses if the business fails. The failed startup would then be responsible for repaying investors.

Crowdfunding, on the other hand, comes with less financial risk, as startups can avoid the need to repay investors if their venture fails. At the same time, investors can avoid significant financial loss if they make no real investment in the company.

Potential gains

Traditional funding involves investors who expect some form of financial gain, whether it's in the form of shares and revenue for angel investors or interest on loans for financial institutions. Conversely, investors who contribute through crowdfunding don't typically anticipate these types of gains with the donation-based model. Instead, you can offer other rewards to investors that aren't as financially impactful.

These are simply a few differences to consider between crowdfunding and more traditional funding strategies.

Crowdfunding considerations for startups

For startups of all types, crowdfunding comes with certain advantages and disadvantages to consider. Knowing these will help you make the right decision when choosing between crowdfunding and other methods.

The benefits of crowdfunding

Some specific advantages of crowdfunding include:

  • The ability to test the market — Unlike traditional investing methods, you can use crowdfunding to test the market without the need to have a fully prepared business and website. 
  • Centralized communications — One main benefit of crowdfunding is the ability to centralize all investor communication on a single portal. Traditionally, you would need to use multiple channels of communication to facilitate fundraising, including phonecalls, emails, and in-person meetings. Through a crowdfunding platform, you can ensure everyone is on the same page with a single update.
  • Donors finance products and services — Crowdfunding eliminates the need for startups to fund their offerings when they have a winning idea. Instead, donors fund these while business owners retain equity.
  • Establish your target market — When reaching out to others for crowdfunding campaigns, you'll be able to attract people who are actively interested in your brand and offerings. These people will likely be the best target market to reach as you further grow your business. Based on these audiences, you can better determine who to pursue with future offerings and marketing efforts.
  • Get the chance to go big — Another advantage of crowdfunding is the ability to flourish in your industry and achieve the same level of success as your biggest competitors. Consider a success story like the Oculus Rift, which began as a humble project on Kickstarter and has since become a leading brand in virtual reality tech.

What to keep in mind about crowdfunding

Crowdfunding is beneficial for many, but there are certain aspects to keep in mind, such as:

  • It can require a lot of effort — To get the best results for your startup, you will need to launch a comprehensive campaign. This entails a lot of work and does require an initial investment from you, mainly for marketing content such as videos, PR, and ads. Otherwise, you're unlikely to attract a large number of investors.
  • Negative feedback can hurt — Even if you have a perfectly valid business and high-quality offerings, you're more likely to feel negative feedback with crowdfunding. A simple negative comment about your startup, individual employees, or offerings could negatively impact your campaign and business.
  • Crowdfunding doesn't suit every brand — Depending on your industry, you may want to seek funding using another method. For instance, luxury brands don't tend to fare as well with crowdfunding as brands with offerings that provide more practical value.

Partner with us

DigitalOcean supports builders of all kinds through our global startup program, Hatch. Learns how you can build and grow your startup with simple infrastructure solutions like Droplets and App Platform. To sign up for a DigitalOcean account, click here.

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