Crowdfunding Takes Off for Small Businesses

It’s been a four full months since the Title III equity crowdfunding provision of the Jumpstart Our Businesses (JOBS) Act went into effect, allowing small businesses and startups to raise up to $1 million annually in crowdfunded securities investments from both accredited and nonaccredited investors. As of Sept. 15, businesses had raised more than $7 million in capital investments using Title III.

Although Title III is a particularly young section of the JOBS Act, it’s been hailed as a potential game changer for small-scale financing. Whether a company’s projected growth is too flat to interest venture capitalists or an owner simply doesn’t want to end up beholden to one highly powerful investor, Title III is seen as a way to raise growth capital without sacrificing independence. Moreover, campaigns can be targeted at locals within a business’s community, helping to build a loyal customer base that maintains a stake in the company’s success. [See Related Story: Title III Crowdfunding Ruling Changes Startup Fundraising for Good]

“I think Title III will change financing. If you look at how the industry evolved in Great Britain when they did it, we’re already growing faster than they were,” Mike Norman, CEO of equity crowdfunding platform WeFunder, said. “It will take a little time, as any new securities legislation does. Awareness is the biggest challenge right now. A true test and the most compelling part is that we now have companies that have raised meaningful funds from investors. How can they activate those investors in terms of promotion and customer loyalty?”

WeFunder has tracked the growth of the equity crowdfunding industry so far, and the early statistics appear promising. More than 9,000 investors have contributed $7.14 million so far, helping to fund 29 successful offerings, three of which raised the full allotted amount of $1 million in capital. In just the past seven days, investors from the crowd have contributed $112,068 to small businesses.

For companies like stock-photography gallery Snapwire, which crowdsources made-to-order photos from over 300,000 photographers worldwide, leveraging the power of an already-engaged community led the company to immense success in its Title III equity crowdfunding campaign. In 72 hours, Snapwire had eclipsed its fundraising goal. Now, the company holds about 280 percent of its goal in investments.

“The very truthful reason we got into equity crowdfunding is that we struggled to raise capital from traditional [venture capitalists],” Chad Newell, CEO of Snapwire, told Business News Daily. “We were such a leader in doing this — nobody had run a successful campaign yet at the time. I had little expectations other than a fair degree of confidence that we’d be successful.”

Lending Right for Your Business

So, your company needs money that you currently don’t have. Maybe your business is just taking flight and is still lacking the necessary funds, or perhaps you have high aspirations with low profits at the moment.

If loans are your go-to choice for financing, you’ll need to decide between a traditional bank loan and an alternative lender. For the latter, peer-to-peer (P2P) lending might be a smart option if you’re looking for a smoother, faster borrowing process.

According to Investopedia, P2P lending lets individuals borrow and lend money without an official financial institution as the intermediary. Lenders collect income from interest, usually at a higher cost than with traditional loans, while borrowers access financing they may not have been approved for elsewhere.

“P2P loans can often offer higher approval rates and competitive interest rates — a stellar combination,” said Emily Bartz, a writer at NextAdvisor.com, which provides independent research and comparison tools for financial, tech and business products. “The beauty of P2P lending is that it offers borrowers a more personal experience by avoiding big banks and financial institutions. Plus, borrowers can rest easy knowing that their lender is accredited and provides legitimate loan support.”

Another upside, according to Bartz, is that P2P lending is flexible, allowing borrowers to complete the process in pieces. [See Related Story: A Guide to Choosing the Right Small Business Loan]

 

Is P2P right for you?

So how can you determine if P2P lending is right for your business? Be sure to ask yourself these questions:

 

Is it legal in your state?

Not all states allow P2P lending. However, it may depend on the platform you use. For example, according to LendingMemo, 49 states provide funding through LendingClub, while only 47 do so through Prosper.

“Potential borrowers should make sure that P2P lending is legal in their state, as it is prohibited in some areas,” Bartz said. “You can usually find this information fairly easily on the lender’s website or by completing a quick Google search,” she noted.

Before committing to the idea, research which sites are accessible in your state.

 

How quickly do you need the loan?

One potential downside of P2P lending is that it might take longer than a traditional loan, thus hurting any immediate transactions or aspirations, Bartz said.

Bartz said that “if you are in a time crunch, P2P lending might not be ideal.” Make certain that your company’s needs are in tune with the time frame of your lending process before settling, she advised.

 

Is your financial standing good enough?

Bartz noted that it’s important to consider costs such as interest rates and origination fees. While not all P2P lenders require this, it’s smart to determine whether your credit score is high enough, and your business makes enough money, for you to be approved.

“It’s crucial that all potential borrowers have a clear understanding of exactly what they’ll be paying and have a plan to keep their payments consistent and on time,” she told Business News Daily.

Choose Your Words Closely

It’s not what you say, but how you say it that could determine how successful your crowdfunding campaign is, new research finds.

A study from researchers at the University of Illinois at Chicagorevealed that linguistic style, which is how one speaks, is critically important in crowdfunding campaigns, especially for social entrepreneurs.

The study’s authors found that how a pitch is voiced and worded is much more important for social entrepreneurs than it is for their commercial counterparts.

“Here, we show that the persuasiveness of entrepreneurs’ stylistic expressions is dependent on their category membership – that is, whether they are social or commercial entrepreneurs,” said Annaleena Parhankangas, the study’s lead author and an assistant professor at the University of Illinois Chicago in a statement.

For the study, researchers analyzed 656 Kickstarter campaigns between 2013 and 2014. They discovered that linguistic styles that made the campaigns and their founders more understandable and relatable to potential funders boosted the exposure and success of social campaigns. However, linguistic style made little impact for commercial endeavors. [Raising moneyv ia crowdfunding? 15 way to increase your chances for success]

“Early-stage entrepreneurs are increasingly involved in the theatrical pitching of their projects to various audiences at forums, such as accelerator demo days, pitch mixers, competitions and online crowdfunding sites,” Parhankangas said. “How they deliver the message matters – and, as a result, it is important to study how entrepreneurs’ language use affects their chances of raising funding.”

The study was co-authored by Maija Renko, a UIC associate professor of entrepreneurship.

The researchers said style doesn’t matter as much for commercial entrepreneurs. Instead, content is likely to be enough to persuade their audience to invest.

Great Ways to Use It for Growth

Unless you’ve aggressively saved money to bootstrap your business, you’ll likely need to borrow money at some point to make ends meet, whether it’s a formal loan through a bank or online lender or an informal one from family and friends.

Regardless of the amount or source of your loan, it can be tempting to make those big “nice to have” purchases when the money hits your bank account. However, it’s important to plan your spending carefully and allocate borrowed funds toward expenses that will ultimately accelerate your business’s growth.

We spoke with small business lending experts about smart ways to put business capital to work.

 

1. Equipment and operational costs

When you’re just starting out, you may not necessarily have the funds for all the basic elements your business needs to function. Jay DesMarteau, head of commercial bank specialty segments at TD Bank, said early-stage businesses will often use their funds for operational necessities such as buying inventory and building products.

“We are also seeing higher demand for lines of credit, which typically are used to finance short-term needs, such as buying or leasing equipment, purchasing a company vehicle or injecting cash into the business during a lean period, especially seasonal businesses,” DesMarteau added.

 

2. Payroll and hiring

A company is only as strong as the people behind it, and investing your new loan funds in hiring can be a great way to help your business grow.

“True growth means spending funds to add employees who can take over some tasks such as bookkeeping or ordering supplies and help support the daily functions,” said DesMarteau. “This will allow the business owner to better focus on long-term strategy and driving profitable revenue growth.”

Isaac Rodriguez, CEO of Provident Loan Society, notes that as a not-for-profit collateral lender, most of his organization’s loans are made for short-term expenses such as meeting payroll.

 

3. Soft costs

“Soft” costs, as opposed to “hard” physical assets or products, are those expenses that don’t directly help create a product or provide a service but are necessary to keep your business functioning. This includes things like licenses, marketing campaigns and professional fees, said Rodriguez. This could also cover fees for advisors like CPAs, attorneys and bankers.

“Maximize the use of capital,” Rodriguez told Business News Daily. “For example, don’t just pay legal fees and get tax returns done – explore how those professionals can help grow your business through referrals, recommendations, introductions, etc.”

What You Need to Know About Business Financing

Startup financing is a huge consideration and an important decision for any aspiring entrepreneur. There are plenty of ways to fund a business, and whether you borrow money, dip into your savings or go another route, you need to understand your options before you choose.

While these are far from the only ways to finance your startup, here are three of the most popular methods today’s entrepreneurs choose.

The notoriously high rejection rate of bank business loans combined with the proliferation of online lenders has made traditional business lending seem like it’s not even worth the time and effort. But plenty of small business owners still turn to local and national banks, as well as the Small Business Administration (SBA), to help them finance their operations.

“There’s still a lingering perception out there that banks aren’t lending, but that’s not true,” said Jay DesMarteau, head of regional commercial specialty segments at TD Bank.

“Traditional bank loans typically offer better terms and build credit, but the arduous [process] that comes along with this type of financing often overextends time-to-credit necessary to meet the small business’s needs,” added Matt Schaffnit, CFA, co-founder and COO of Lending Technologies Corp.

 

Alternative lending

Alternative lenders provide quicker, smaller, more flexible loans through an online application and transfer process. Depending on your credit score, you can be approved for a loan in a matter of minutes and have your money in just a day or two.

While having all these options can be great for businesses that may not qualify for a traditional bank loan, it also means you’ll need to be much more diligent about researching potential lenders and their reputations. Sabrina Parsons, CEO of Palo Alto Software, said that although online lenders will make a lot of promises about their funds, some are just “sharks” out to take advantage of small business owners.

“These sharks will charge business owners to ‘qualify’ for a loan and to have access to their lenders,” Parsons said. “[Also, some alternative] loans can come at a very high interest rate, and business owners need to understand the implications of these types of loans.”

Editor’s Note: Looking for information on business loans? Fill in the questionnaire below, and you will be contacted by alternative lenders ready to discuss your loan needs.

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Schaffnit said the biggest trend in alternative lending is consolidation, and he believes this trend will persist.

“Newer alternative lenders are learning that managing net interest margin is more important than they realized,” he added.

He further noted that if the Trump administration follows through in lightening the regulations on lending, it could have a positive effect on small businesses’ ability to access capital from more traditional and thus more affordable sources.

“However, we also foresee an overall increase in regulations trending over time,” said Schaffnit. “We believe these side effects will be net-positive.”

 

Bootstrapping

Funding your business out of your own pocket – commonly known as bootstrapping – is the simplest but potentially most difficult financing route. On the one hand, you are in total control of your finances; you don’t have to make any payments to lenders or share equity with investors. On the other hand, you’re on the hook for every penny you sink into the company, and if it fails, your personal funds are going down with it.

“We see entrepreneurs end up in a position where growth and revenue is strong, but because of long payment cycles, they are short on cash to meet payroll, purchase supplies or acquire inventory,” said Ed Castano, principal product manager at TriNet. “Understanding your options, whether it be a bank line of credit, invoice financing, purchase order financing or something else, can be the difference between expansion, stagnation or layoffs for a small business.”

Bootstrapping is more about necessity than preferred method of financing, according to Schaffnit. More often than not, there is simply no other source of funding available to bootstrappers because they are too early-stage or lack the scalability for loan or venture financing, he said.

Goals Inspire Backer Confidence

While success or failure in crowdfunding campaigns hinges on a variety of factors, the most important aspect is the level of confidence backers have about the campaign’s outcome, according to a study by the University of Michigan, University of Toronto and Google.

“Pledging is not costless, and hence consumers would prefer not to pledge if they think the campaign will not succeed,” the study’s authors wrote. “This can lead to cascades where a campaign fails to raise the required amount even though there are enough consumers who want the product.”

When deciding whether to back an entrepreneur’s crowdfunding campaign, backers examine multiple factors, including the price of the product, how much has been raised, the funding target and how long the campaign lasts.

“The absence of early pledges makes those who arrive later pessimistic about the chances of campaign success, and therefore discourages them from pledging,” Mohamed Mostagir, one of the study’s authors and an assistant professor at the University of Michigan, said in a statement. “This can create a vicious cycle where even good products can fail.”

The opposite can hold true as well, according to Mostagir. He said early funding on a campaign can create a cascading effect that propels a campaign well past its funding goal. [See Related Story: Crowdfunding Entrepreneurs Should Sell Themselves First]

Based on their research, the study’s authors suggest that entrepreneurs consider a lower funding target in order to reduce the uncertainty in a backer’s mind about the chances of a campaign’s success.

They use the Coolest Cooler campaign on Kickstarter as an example. The campaign was first launched in 2013 with a funding goal of $125,000. At the time, it never reached its target.

However, when the campaign was relaunched several months later with a funding goal of only $50,000 it was wildly successful. The second campaign raised more than $13 million, making it the largest funded project in Kickstarter history at the time.

The study’s authors admit, however, that there are some risks to this type of approach.

“Of course, the downside to the strategy of shading the real target is that it is possible that the campaign ends up raising enough money to cover the artificial target — and hence ‘succeed’ — but not the actual one,” the study’s authors wrote. “This leaves the seller with a commitment to deliver a product that it does not have enough means of producing.”

In addition to considering a lower funding goal, it is also important to make sure backers can see in real time how much a campaign has raised, according to the research. The study’s authors said that if the backers can always see the current funding level, they may be more inclined to start pledging when they see that a campaign is doing well.

Overcome Gender Bias in Funding

There is an unconscious bias among venture capitalists that is preventing female entrepreneurs from securing more funding, new research suggests.

A study set to be published in an upcoming issue of the Academy of Management Journal revealed that venture capitalists have different expectations of men and women entrepreneurs, which in turn impacts how much, if any, money they give them.

The research argues that the bias comes in the form of the questions venture capitalists pose to entrepreneurs when trying to learn more about their startups. Specifically, women are asked questions that focus on how they won’t lose a venture capitalist’s money, while the questions to men focus on how much money they can make.

“Female entrepreneurs are implicitly expected to prove that they can execute a safe return for the investor, whereas male entrepreneurs are instead expected to show the opportunity can grow,” the study’s authors wrote.

In turn, the answers the entrepreneurs give match the focus of those questions. The researchers said this prompts female business owners to position their startups as “playing not to lose,” referred to as prevention-focused, while men are better able to position themselves as “playing to win,” referred to as promotion-focused – the latter of which is much more appealing to investors.

The study’s authors said the unconscious bias comes from investors of both genders.

“Both male and female venture capitalists display implicit bias, holding men and women to different standards, [which] implies that the funding disparity cannot be corrected by merely ensuring that more female VCs are in a position to evaluate investment opportunities,” the study’s authors wrote.

Researchers came to their conclusions after analyzing the questions posed by venture capitalists at TechCrunch Disrupt, a startup competition held annually in major cities around the world. Since its launch in 2009, entrepreneurs who have presented at the competition have raised about $7 billion in venture funding over their lifetimes.

For part of the research, the study’s authors looked at data involving 189 startups that presented at the New York competitions organized by TechCrunch Disrupt from 2010 through 2016. The researchers specifically looked at video footage of Q&As between each company’s founder and a panel of venture capitalists. After transcribing all of the videos, they were able to determine the balance between promotion focus and prevention focus in company-panel interactions and the relationship of this balance to companies’ funding achievements over time.

How Much Cash Will You Need

If you’re thinking about launching a new business, you may not know where to start with your finances. Of course, you’ll need a decent amount of cash flow to maintain your company. However, if you are organized and thorough, you can plan out your financing and keep your startup budget on track.

Here’s how to figure out approximately how much you’ll need to launch your business.

 

Start small

You most likely have high expectations for your company. However, blind optimism may cause you to invest too much money too quickly. At the very beginning, it’s smart to keep an open mind and prepare for issues that may arise, experts say.

Cynthia McCahon, founder and CEO of business-plan software company Enloop, said business owners should start with a bit of healthy skepticism.

“A prospective business owner should start planning a small business by simply understanding the potential of the business idea,” McCahon told Business News Daily. “What this means is not assuming your idea will be successful.”

The best approach is to test your idea in a small, inexpensive way that gives you a good indication of whether customers actually need your product and how much they’re willing to pay for it, McCahon said. If the test seems successful, then you can start planning your business based on what you learned. [See Related Story: Creative Financing Methods for Startups]

 

Estimate your costs

While every type of business has its own financing needs, there are some tips that can help you figure out how much cash you’ll require. Entrepreneur Drew Gerber, who started a technology company, a publicity firm and a financial planning company, estimates that an entrepreneur will need six months’ worth of fixed costs on hand at startup.

“Have a plan to cover your expenses in the first month,” Gerber said. “Identify your customers before you open the door so you can have a way to start covering those expenses.”

When planning your costs, don’t underestimate the expenses, and remember that they can rise as the business grows, Gerber said. It’s easy to overlook costs when you’re thinking about the big picture, but you should be more precise when planning for your fixed expenses, he added.

Indeed, underestimating costs can decimate your company, McCahon said.

“One of the main reasons most small businesses fail is that they simply run out of cash,” she said. “Writing a business plan without basing your forecasts on reality often leads to an unfortunate, and often unnecessary, business failure. Without the benefit of experience or actual historical financials, it’s easy to overestimate a new company’s revenue and underestimate costs.”

A Funding Match Made in Heaven

Equity crowdfunding, a method of raising capital from small-dollar investors implemented by Title III of the Jumpstart Our Business Startups (JOBS) Act, came online nearly a year ago. The measure was touted as an alternative way to finance both early-stage and local companies that might have trouble securing a loan or attracting more conventional investors.

By its nature, equity crowdfunding is a horizontal endeavor; companies soliciting small investments register with the SEC through an intermediary platform and begin to build capital toward their goal. If they reach that goal, they receive the funding and the investors officially become shareholders. One intermediary platform, GrowthFountain, saw an opportunity to merge the concept of equity crowdfunding with another kind of horizontal institution: the credit union.

Credit unions are financial institutions similar to banks, except for one major difference: Credit unions are not for-profit entities, but rather cooperatives. Each account holder in a credit union is a part owner that retains a democratic stake in the institution and receives dividends in the form of more favorable interest rates, whether it’s on deposits or loans. Marrying equity crowdfunding with credit unions was a no-brainer, said Ken Staut, CEO of GrowthFountain.

“When we formed GrowthFountain and thought about crowdfunding, a lightbulb kind of went off over my head,” Staut told Business News Daily. “Our mission has so many similarities with a credit union’s. We’re both focused on people helping people and community development.”

 

The intersection of equity crowdfunding and credit unions

After Staut realized equity crowdfunding and credit unions should go together, he reached out to Callahan & Associates, a prominent credit union think tank, to gauge some of the unions’ interest in offering access to GrowthFountain’s equity crowdfunding platform. It turned out interest was immense, Staut said. Although the company is still early in the process, it already has three credit union partners: Digital Credit Union, a top 10 credit union with 620,000 members across 50 states; Massachusetts-based Jeanne D’Arc Credit Union with 85,000 members; and Oregon-based Rivermark Community Credit Union, also with 85,000 members.

About a dozen more contracts are in the works, and Staut estimates that when the ink is dry, GrowthFountain’s equity crowdfunding platform will be available to roughly 3 million credit union members nationwide.

Each credit union leverages GrowthFountain’s platform, but the branding and imagery is all unique to the credit union that’s offering it to members. The foremost businesses displayed on each site are unique to the geographic region in which the credit union operates as well, meaning members can invest in local companies – maybe even ones they visit and patronize.

 

Keeping the money in the local economy

Equity crowdfunding boasts the ability to keep wealth in local communities, which complements the financial cooperative nature of credit unions. When investors are regular people receiving small dividends, instead of large venture capitalist firms or private angel investors in far-off cities, the money tends to remain in smaller economies.

“These credit unions are jumping at the opportunity to add equity crowdfunding as a tool for their members,” Staut said. “The profits [from crowdfunded companies] stay local and recirculate in that economy, so I think the potential for us to work with credit unions to support local businesses is something you wouldn’t usually get from a conventional bank.”

There are limits, however, to how much equity individual investors can purchase. Under the Title III equity crowdfunding rules, investors with either a net worth or annual income below $100,000 are restricted from investing more than 5 percent of their annual income or net worth, whichever is less. Those with a net worth or income greater than $100,000 remain restricted to 10 percent, and no investor may purchase more than $100,000 in securities in one year through all crowdfunded offerings.

Market Your Equity Crowdfunding Campaign

Equity crowdfunding, a creation of the 2012 Jumpstart Our Business Startups (JOBS) Act, is an alternative way for startups and small businesses to crowdsource capital from investors and consumers who are passionate about their products or services. However, running an equity crowdfunding campaign can be difficult; there are many startups vying for the crowd’s dollars, and making your voice heard in a sea of exciting ideas can be difficult.

The success of these types of campaigns largely rides on how you market your company to the crowd. Establish a unique brand and a voice that cuts through the clutter, and you’ll get you the capital you need to get moving. Fail to forge an essential emotional connection, and your equity crowdfunding campaign could end in failure. Here’s how to make sure your crowdfunding endeavor pays off in both capital raise and brand awareness. [Want to start an equity crowdfunding campaign? Read this first.]

 

1. Know your audience and cultivate relationships.

The first step toward any successful equity crowdfunding campaign is to understand your audience. What are their needs or desires? Why would they support your product? Even more importantly, why would they be passionate about your product? Forging an emotional connection starts with understanding your potential supporters and catering to their needs, both with a quality product and impactful storytelling.

“Emotional connection really comes when you understand your audience and the people you’re trying to reach,” said Chris Westfall, a pitch strategist and author of “Bulletproof Branding” (Marie Street Press, 2014). “Oftentimes for entrepreneurs, this means look for the impact. Giving people something to believe in, that emotional connection, that’s what [draws the crowd].”

Reaching the correct audience is also a matter of medium and messaging, said Mark Stanich, president with the ELEQT Group. High-quality photos and video are huge boosts when it comes to marketing ideas; allowing potential investors to place themselves in the shoes of a satisfied customer brings them one step closer to understanding the value of your idea. It’s also imperative to speak to the things that make your idea stand out from the rest.

“In terms of actual messaging, why is it different than competition? How does it fit a true need or desire for your lifestyle? Is it simple to use? [Does it] free up time to do other things? Make life easier?” Stanich said. “There’s this area of social investing that’s becoming very important … If you can speak to those things, you build this emotional bond. Obviously, financial return is important in equity crowdfunding, but I think that’s not enough. I think many people want to support something they really believe in.”

 

2. Keep it simple.

Keep your message simple. Overwhelming audiences with too much information or the slew of benefits your product provides – even if they’re all valid – is a surefire way to lose their attention. The shorter and sweeter your pitch, the better.

“You need a simple, distilled description of your product,” Stanich said. “People often launch something and love it and want to go on and on about it, but that’s complicated and noisy. There are lots of other competing products, so you need to keep it very, very simple.

“As you go further down the path of investment, you can flesh the benefits out and talk more and more,” he added.

Consistency and simplicity go hand in hand. That means aligning your brand with the right platforms, speaking to the right audience with the right message, and selling the right idea, Westfall said.

“You want alignment every step of the way,” he told Business News Daily. “Choose the right platform and you’ll reach the right people. But if you have the right idea in the wrong platform, that still adds up to the wrong idea. You want to be careful and deliberate about picking your alignment, from the platform you choose, to the way you approach it, to the methods you use.”

 

3. Build a strong brand.

Without a clear brand and associated message for your campaign, it’s easy to miss opportunities to engage potentially interested investors. On the other hand, if your brand is successful and consistent, it will be much easier to initially grab people and encourage them to investigate your idea further.

“A broad crowdfunding platform gives you a place to stand in the market square, but they don’t give you a megaphone,” Stanich said. “Successful campaigns have [an] existing connections base already with people passionate about [their] product, or if they don’t already have a big base to tap into or influence, they build an emotional bond with passionate people. That’s when you start to get viral pickup … That’s when you see successful campaigns.”