There are a few possible routes into crowdfunding. While it is entirely possible for a business to use it for a standard loan arrangement, some crowdfunders offer up capital in exchange for a stake in the business. Investors often specialise in one of these paths, Crowdcube being one of the most well-known examples of a funder that takes an equity share in the business. As such, businesses should start by considering which type of fund they need to approach.
The sector that a business operates in can greatly influence the options available to them, and each sector has specific funders that cater for it. Crowdfunders that operate in high-risk sectors, such as IT or digital technology, tend to look for higher returns on their investment. On the other hand, for sectors such as manufacturing, funding tends to focus on smaller loans with a more affordable repayment profile.
Aside from sector considerations, start-ups and those who have only been trading for a short period are generally limited to the equity route. Established businesses with a solid customer base and order book tend to have more options because they are viewed as a lower-risk investment.
Identifying where your business fits into these general categories should help a business to decide which fund to approach and how. As with any appeal for external funding, preparation is key to success, and it is vital that the business plan clearly sets out central objectives, explaining what the investment is planned for, and the expected outcomes. Companies that demonstrate such forethought and understanding of their business and its markets stand a much better chance of securing crowdfunding.
While preparing the right details for a robust business plan shouldn?t present too much difficulty, identifying which funders to approach is more complicated. Different crowdfunders tend to prioritise different details within the business plan, and without such knowledge to guide who to approach and how to present the business, seeking funding could become a rather scatter-gun affair.
Business advisors with crowdfunding experience can help to guide a business to the right fund, and provide advice on whether they are likely to achieve the required funding. An advisor can help to ensure that the plan is presented in a way that maximises its chance of success. They could also highlight any issues in the initial stages, such as potential hikes in the interest rate payable, or what penalties are involved if repayment terms aren?t met. Going in well-advised is a must, and ensures full transparency over where the money is coming from and what the costs will be.
For businesses considering crowdfunding for the first time, there are also a number of pitfalls and tips that companies should bear in mind when considering funding options.
Crowdfunding can represent a relatively hassle-free route to finance, and as such businesses can be tempted to disregard other sources. Doing this, however, may narrow the range of options considerably, and the business could end up opting for a less-suitable funding source. In addition, businesses should be aware of what available assets they have that may render crowdfunding unnecessary. A small business with enough equity in its assets, for example, may well find that a standard corporate loan is the best way to fund growth plans.
Setting a benchmark in terms of how much the loan should cost allows a business to consider crowdfunding in the context of the whole lending market. When making these comparisons, it is important to not focus simply on the headline interest rate payable on the loan, but rather on its cost over the full term, which gives a much more accurate cost comparison. Crowdfunding can seem expensive at first glance, with APR on a loan sometimes reaching 12 per cent; but this fails to convey the minimal legal documentation requirements and the fact that arrangement fees are often very small or non-existent, which bring down costs significantly.
Once a crowdfund confirms interest, it is easy to think this is the only option on the table. However, such an offer actually provides businesses with a level of negotiating power, and other lending sources, such as a bank, that may have initially refused funding, could change their position. In some instances, this could result in a better deal for the business.
As a relatively new lending option, some businesses are understandably cautious about opting for crowdfunding. However, such funds are well-regulated, and as long as companies are entering into agreements with crowdfunds with their eyes open, there is no reason to fear. On the contrary, crowdfunding can be a highly attractive way of injecting new capital into plans for business development.
Ross Cocker is a partner and expert in corporate finance at Clement Keys.
