Wednesday, May 25, 2011

Creating Alternative Financing – Crowdfunding & Crowdsourcing: Part IV: Who is an Ideal Candidate for Crowdfunding?

In this post, I would like to summarize the information I posted previously about crowdfunding and discuss the kind of company or individual that would benefit the most from this type of financing. In the donor-based model of crowdfunding, it would be a person or a team with a creative novel idea, something that would make people donate their money to support the idea. It is unlikely that a commercial product or service would get substantial financial backing from donors. After all, donors are not getting any interest in the company. Therefore, it is likely that the most popular projects will be those in the creative field (arts, film, books, etc.).

A start-up looking for seed funding can (and would be well advised to) reach out to their friends and family through an investment-based crowdfunding platform. The advantages include low cost of structuring the investment, the convenience of an internet-based platform to conduct the offering and the ability to raise sizable amounts of money. The disadvantages include (1) limited universe of potential investors (limited only to people with whom founders have pre-existing relationship); (2) legal risks (if founders do not hire attorneys to guide them through the blue sky and federal filings); and (3) limit on the type of investment possible (if the platform offers only one kind of investment structure).

Is crowdfunding a viable option of financing for an already existing business with a multi-million dollar revenue that needs capital for expansion? Platforms like Kickstarter or RockerHub will not be good sources of revenue, as the donors will lack the incentive to donate money to an existing and profitable business. A site like Profounder may not be a good option either, as such platforms tend to be focused on seed capital raises: for example, Profounder specializes in friends and family rounds of investing with an average amount of money raised per company of about $35,000 to $60,000. An established company with multi-million dollar revenue will probably need to raise more money than that, and from accredited or institutional investors. Also, a big company may need to consider the number of investors it wants to attract, if it does not want to trip the 500 shareholder rule. So, a crowdfunding model of investment, where many people contribute or invest small (or relatively small) amounts of cash, may not be the best option for it.

Full series: Part IPart II, Part III and Part IV.

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