crowdfunding or a small business loan

Crowdfunding or a small business loan?

Friday, December 11, 2015

As a small business owner, the concept of crowdfunding is almost too tantalising to resist. There are no loan applications to fill out, no credit checks to process – there aren’t even any repayments to be made.

But if business loan crowdfunding is such a brilliant way to bankroll your small enterprise, why isn’t everyone doing it?

In a nutshell, it’s because even when it works, it can turn bad very quickly. There are many hidden risks involved in crowd fund loans, and they can have a significant impact on your bottom line.

How crowdfunding works

Crowdfunding is a platform that allows organisations and individuals to raise a little money from a lot of people, generally in exchange for a small reward.

For small businesses, the major benefit of a crowdfunding loan is that it can act as something of a ‘mass pre-order’ platform.

Let’s say you’re a small business trying to market and sell an innovative beach umbrella product, for instance. You sell these umbrellas for $20 a piece and you were planning to apply for a bank loan of $20,000 to get your production run started.

Instead, you attempt to get a crowdfunded loan, offering an umbrella as a ‘reward’ for a $20 contribution. If 1,000 backers contribute $20 each, you’ll essentially lock in 1,000 pre-orders of your new product, while generating the cashflow you need to commence production.

Everybody wins, right? Not necessarily.

Crowdfunding in practice: ButterUp

A number of Australian businesses have successfully raised capital via crowdfunding loan sites such as Kickstarter and Indiegogo.

Throughout 2014, more than 550 Australian projects raised over $14 million in funding through Kickstarter. One local business included in this mix was DM Initiatives, creators of The Stupendous Splendiferous ButterUp, a specially designed knife that softens butter straight from the fridge.

The quirky and unique product was uploaded to the crowdfunding site with a modest fundraising goal of $38,000. They well and truly blitzed that estimate and went on to raise over $360,000 from 15,250 backers.

In other words, more than 15,000 people across the world agreed to pre-order and pre-pay for the ButterUp knife, thereby allowing DM Initiatives to bypass a traditional bank loan and get stuck into manufacture, marketing and order fulfillment.

The business was understandably thrilled: they immediately expanded their vision and invested in a much larger production facility, to help them fulfil the thousands of orders they were flooded with.

But before long, the drawbacks of getting too big too soon began to emerge. 

The danger of getting too big, too soon

Orders were posted, but went missing. Some backers moved during the lengthy fulfilment process, so packages were returned to sender. Many orders weren’t sent at all, as address details were incomplete, and the business admits they “grossly underestimated” the costs involved of shipping parcels internationally, which prompted them to ask customers for an additional $6 postage fee.

In the midst of this, they were also refining their prototype and tweaking the design to ensure the final product was the best possible quality.

Ordinarily, if they had run with a standard business loan and product development strategy, this process would happen behind the scenes well before the product launched. But because they had turned to a crowd funded loan to launch their product, it was evolving under the watchful eye of 15,000-plus customers.

ButterUp learnt first-hand the many pressures that can arise when you have too many customers, too early in your business cycle. This is just one of the risks of loan crowdfunding; others include:

A lack of community support

Ideally, you need a loyal, engaged community to tap into to have success with a crowdfunded project. If you’re starting from scratch, you’ll need to drum up support and promotion from a large number of backers – think friends, family, colleagues, online communities and perfect strangers – to help you stand out against a sea of other crowdfunders.

If you don’t reach your goal, you don’t get funded

There’s a lot of uncertainty involved in the crowdfunding process, which can leave you (and your business) in limbo. Say you set a goal of $10,000. If you successfully convince backers to pledge $8,000, you don’t get a cent – and all of the time, energy and resources you’ve invested into promoting and sharing your crowdfunding campaign are for nothing.

Your existing business may suffer

While you’re busy running your crowdfunding campaign and trying to get people excited about supporting your vision, who is running your existing business? Will you have time to do both – and if not, how much is it going to cost to pay people to manage your business in the interim?

Why do small business loans make more sense?

Ultimately, the success rate for those attempting to seek crowdfunding business loans is extremely low, with small business projects faring the worst of all. According to one report, just 3.1 per cent of small business’s 20,000 projects reached their goal on Indiegogo – meaning a whopping 97 per cent of business owners were unsuccessful in obtaining a crowd funded loan.

A small business loan, on the other hand, allows you to build and launch your product or business in a safe, low-key way, without fielding pressure from customers before you’ve had a chance to refine your product.

Small business loans can be arranged under flexible contracts designed that meet your needs, whether you require short-term bridging finance or a long-term funding arrangement. You can lock in the most appropriate terms to your situation, such as a fixed rate for repayment certainty, and organise the loan over a repayment timeframe that suits your business.

Also, for those seeking friendly payment terms, it’s possible to structure your loan with a lump sum ‘balloon payment’ ­– accounting for up to 80% of your total small business loan amount – to be paid at end of the loan term. This can help you free up essential cashflow during the growth and development stage of your business lifecycle.

Overall, small business loans generally offer a safer, more structured and consistent model for financing your small business when compared to crowdfunding. For the lion’s share of Australian small businesses, it often makes more sense to approach a bank for business finance.