Rewards-based Crowdfunding

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April 18, 2016
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This blog post is the second in a series of three articles by Millyard Tech Law, PLLC exploring the use of crowdfunding for funding a small business.  The information provided is intended to provide an overview of the subject and is not a substitute for legal or business advice.  We encourage you to consult with a SBDC business advisor to explore whether crowdfunding is right for your business. Check out this article to see how SBDC's client Popzup used Kickstarter, a rewards-based crowdfunding platform.

 

In our first blog post, we explored what crowdfunding is, its benefits and the keys for crowdfunding success.  In this article, we are exploring when and why a business may want to consider rewards-based crowdfunding.  As a reminder, rewards-based crowdfunding allows entrepreneurs to pre-sell a product or service or to launch a business concept without incurring debt or selling equity.  Supporters receive rewards, such as discounts off the product or service once it is released, in exchange for supporting the project now. 

Rewards-based crowdfunding can be attractive to companies for a number of reasons:

  • Low risk.  Businesses running a rewards-based crowdfunding campaign are really in the driver’s seat when it comes to designing their campaign.  They set the levels of rewards and once the rewards are delivered to supporters, there really is no further obligation.  There are no credit checks or massive investment documents to be prepared.  This isn’t to say that crowdfunding campaigns do not require a lot of work.  They most certainly do but the exposure in terms of upfront money to launch a campaign is entirely within the control of the business.
  • Low cost.  Online crowdfunding platforms do charge a percentage of the funds raised (around 5%) but they are relatively low cost solutions especially given the features of the platforms that make managing a campaign much easier than if a business was doing it all itself.
  • Broader exposure to a target audience. Crowdfunding helps businesses connect with people who are interested in using their products or services.  Not only does the business raise capital but this ability to connect with supporters who can provide feedback on product design and can be champions of the business to other potential consumers can be a huge benefit.

Crowdfunding is also seen as being trendy.  There have been a number of well known rewards-based crowdfunding campaigns over the past few years that have raised the visibility of crowdfunding – some of which have been smashing successes and others that have achieved notoriety simply for being outlandish and ridiculous.  In the realm of smashing successes, there is the story of Pebble Technology.  The founders of Pebble used Kickstarter to pitch their idea of bringing a relatively inexpensive watch to the market that could be customized with apps to do things like display calendar notifications and emails.  Pebble outlined its idea on Kickstarter, made a video about the product and set a goal of $100,000 to complete research and design of the watch.  A donation of $100 earned supporters a promise that they would receive the watch when Pebble began selling them.  The campaign landed more than $10 million from 69,000 supporters.  In the realm of the ridiculous is Zack Brown, the gentlemen from Ohio who raised over $55,000 to make potato salad for the first time.  Mr. Brown offered supporters such rewards as saying their name out loud when making the potato salad.

While the examples above illustrate that rewards-based crowdfunding can be used for just about anything, if you are seriously considering a crowdfunding campaign for your business, below are some situations that are particularly well-suited for using rewards-based crowdfunding:

  • The business is still working on the product concept.  Rewards-based crowdfunding is a relatively inexpensive way to do market research to determine whether your product concept has value to consumers.  If the crowd is excited by your concept, supporters will contribute to your campaign.  If funded, this type of market feedback can be used by the business even after the campaign closes.  A startup can continue to solicit feedback from its contributors as to product features that are most important to them while R&D is being completed so that when the product is released, the business can have some confidence that it is meeting a market need.
  • The business concept is based upon social innovation.  If your business plan involves solving a social issue, allocating profits to charitable purposes or societal improvements or otherwise operating such that maximizing profits to shareholders is not the highest priority, rewards-based crowdfunding can help you find people who are supportive of your cause and willing to help fund your business plan and who are not concerned about receiving large personal rewards in return. 
  • The business is in a niche market or will achieve smaller market share.  Traditional investors invest in startups that have the potential for capturing huge market share that will lead to a huge return on investment.  For a business that operates locally or within a niche market, rewards-based crowdfunding can be used to draw support from a smaller but well-defined group of potential customers than what typical investors would be looking for with their investments in companies with greater potential for capturing market share.
  • The founders do not want to give up equity or incur debt.   If the founders have already raised some money from friends or family or simply don’t wish to have their own investments diluted by additional investors, rewards-based crowdfunding allows a business to raise capital with very few strings attached.  Once the rewards to supporters have been satisfied, there is no further obligation to the supporters, and the founders can continue operating the business free from the scrutiny of investors or lenders whose financial objectives may be different than those of the founders.

Even if you determine that your business might be a good fit for rewards-based crowdfunding, remember that online crowdfunding platforms have an “all or nothing” requirement.  In order for you to receive any funds, you must secure commitments for the entire amount that you are seeking to raise. 

Good planning is critical to your success.  It will start with having a good business plan and a solid grasp of your capital needs.  Then you will need a marketing strategy to raise awareness about your campaign.  

Crowdfunding is all about selling your concept and getting the crowd excited enough by your idea to provide financial support. You’ll want to be in the planning phase of a crowdfunding campaign several weeks before you even go online to set it up.  Speaking with an SBDC business advisor or another company that has used rewards-based crowdfunding with their business are good first steps.

In our final segment, we will discuss when and how to use equity crowdfunding in more detail.  Stay tuned!

Would you like more information on equity crowdfunding?  Check out this e-book Getting Ready for Crowdfunding from Millyard Tech Law, PLLC.

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