Over the last several years crowdfunding has become an increasingly popular option for both entrepreneurs and investors trying to raise capital—and public awareness—when launching or growing a small business.
Rather than approaching a single lender to make a significant loan to your business (which you will most likely need to personally guaranty), crowdfunding platforms give you a way to leverage your network of friends, family, social media connections, and the public at large to obtain significant capital in small increments.
It’s a collective online effort that can expand your professional network and introduce your business to potential customers.
Crowdfunding for businesses presently comes in three primary forms:
· Rewards-based crowdfunding (such as via Kickstarter and Indiegogo)
· Equity crowdfunding (such as via CircleUp)
· Peer-to-peer lending (such as via Lending Club)
With rewards-based crowdfunding, you are only promising your backers some sort of token incentive and the risks are more limited. Whereas with equity crowdfunding, you are giving up equity and the risks can be substantial. With peer-to-peer lending, the business is taking on debt that it is legally obligated to pay back.
Equity crowdfunding and peer-to-peer lending are governed by a complicated web of federal and state securities laws, while rewards-based crowdfunding is generally exempt from those laws.
According to SCORE mentor and Houston entrepreneur Nick Tarte, rewards-based crowdfunding has rapidly become an accepted way to raise capital for small businesses.
“Traditionally, companies raised capital by issuing debt or equity,” says Tarte. “Rewards-based crowdfunding introduced a completely new alternative. The model has shown that the public is willing to contribute capital to worthy projects without any expectation of future profit, which is quite revolutionary.” But be sure to pick the right platform for your rewards-based campaign. Remember, crowdfunding is a form of marketing, and you want to be where your customers are.
Tarte advises to make sure you follow through on your promises. Watchdog groups and state and federal consumer protection bureaus have begun to shift their attention to deceptive crowdfunding campaigns.
Don’t forget about taxes. Proceeds raised from rewards-based crowdfunding campaigns are usually treated as taxable income to the business. For this reason, Tarte advises businesses to consult with their tax advisors before embarking on a crowdfunding campaign.
Nick Tarte will present the details of this increasingly popular but often misunderstood funding option at the SCORE workshop “Crowdfunding – An Alternative Source of Funding” on December 5. To learn more and register for this workshop, go to www.houston.score.org/localworkshops.
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