How Can Startups Leverage Crowdfunding?
Why do most startups fail even before completing 5 years in business?
Is it because they are not innovative enough? Or is it because they do not get the funding that they need?
It’s almost always harder to raise capital than you thought it would be, and it always takes longer. So plan for that!
Venture Capitalist and Author Richard Harroch says, “It’s almost always harder to raise capital than you thought it would be, and it always takes longer. So plan for that.”
Indian Startups seem to be doing great. According to Mint, They have raised $3.9 billion across 292 deals in the first half of 2019, which is 44.4% higher than the figures for the first half of 2018.
However, according to National Association of Software and Services Companies the seed-stage funding for startups in India has declined from $191 million in 2017 to $151 million in 2018. So, in spite of a growing Indian Startup ecosystem, there is a continuous decline in the seed-stage funding of new companies. Taking a hit at the seed stage will surely hamper the innovation and drive of the entrepreneurs.
Startups need most protection at the seed-stage as it can mean the difference between being in business and being out-of-business.
Why do most startups fail?
A study by the IBM Institute for Business Value and Oxford Economics found that 90% of Indian startups fail within the first five years.
India is the 2nd largest market in the world after China. It is also the 5th largest economy in the world as per the GDP data.
India can seem to be a promising land for startups, with its large, growing economy and the availability of one of the largest markets on Earth. But, do not be deluded. These factors do not guarantee success. Success, for all startups, depends on innovation and efficiency. The ones that are not innovative or efficient enough end up failing.
Young entrepreneurs need to constantly think out of the box. They need to be creative in finding solutions to all the problems that they encounter in business. They also need to explore and brainstorm all possible ways in which they could increase the efficiency of their business. Every step, from initiating a business, finding investment, to the actual manufacture and delivery of the finished product, has to be done with an innovative spirit.
The two major reasons why most startups fail are lack of funding and lack of innovation. It is vital for a fledgling business to get investment at the seed-stage. Failure at the seed stage puts added pressure on the entrepreneurs thereby hampering their creativity and innovative capabilities.
Problems faced by Startups in India
Every startup enterprise in every industry has its own specific problems and challenges. But, some challenges are common to all startups across various industries.
Obtaining funds is a major issue for most startups. Venture Capital and Angel Investments are in the early stages of development and hence, not easily available to most. Also, there is the added issue of lack of trust with difficulties in gaining trust in India. Due to a lack of trust, people are mostly unwilling to invest in new ventures.
It is difficult for startups to gain the confidence of investors and potential clients in India. In a culture that idolizes frugality, it is difficult to get people to spend on something new. So, startups struggle not only to find investors but also to find the initial customers.
The university education system in India is weak. This creates a scarcity of well-educated creative people, who are willing to work. Hence, startups find it difficult to get qualified individuals who are efficient and dedicated.
It is quite clear that startups in India have a hard time surviving the initial stages of development. The plurality and extensive nature of problems faced by them make it a herculean task. Not many get past the issues and succeed, but some do. And those that do, get access to one of the largest markets in the world, in one of the biggest economies of the world.
Crowdfunding has the potential to solve a lot of the aforementioned problems faced by startups. But, to leverage crowdfunding, young entrepreneurs should know what it is, how it works and what can it do for them. In the coming sections, we will delve into crowdfunding so that entrepreneurs and businessmen can make informed decisions and use crowdfunding to their maximum advantage.
What is Crowdfunding?
Crowdfunding, as is clear from the name, is all about engaging the crowd or the general public to co-fund projects and startup ventures. Such funding can be provided by any number of individual investors as well as institutional investors.
Crowdfunding provides a platform to anyone with an idea to present it to the general public. Then the public can view it and those interested can choose to invest in the idea for a specific reward or return. Once it reaches its target funding goal, funds are disbursed and the idea can become a real product.
According to a survey, less than 2% of the companies end up raising funds from professional investors. The rest of the 98% still need to raise funds and thus, resort to borrowings, loans or bootstrapping with personal savings.
Crowdfunding provides a healthy alternative to all startup enterprises looking to raise funds. It is a safer alternative to the traditional methods of raising funds.
Types of Crowdfunding entrepreneurs need to know about
There are different types of crowdfunding for different purposes. Depending on your business and its goals, you will have to choose the type of crowdfunding that’s best for you.
Each type of crowdfunding has its own advantages. In this section, we will discuss the different types of crowdfunding so that you will be able to decide which one would work best for you.
1. Donation-Based Crowdfunding
In Donation-based crowdfunding, a large number of individuals donate a certain amount of money towards a project or a cause. There is no expectation of anything in return.
It is usually done by people for the satisfaction of supporting a cause that they are passionate about. Many charities, trusts, social causes, and NGOs lean towards donation-based crowdfunding to raise money for certain medical or social causes.
2. Debt-Based Crowdfunding
In Debt-based crowdfunding, a large number of individuals lend you a small amount, with the expectation that they will be paid back the principal along with the interest. That is why it is also called ‘crowdlending’.
This is somewhat similar to getting a loan from the bank, except that it has more flexibility and more options to get funds and resources. It is extremely helpful to startups at the seed-stage and provides them with the necessary boost to succeed.
3. Rewards-Based Crowdfunding
In Rewards-based crowdfunding, a large number of individuals lend small amounts of money to a project for a reward or an incentive. This is the most popular type of crowdfunding and the rewards can range from the product or service, perks, or simply recognition.
Startups can pick this form of crowdfunding if they wish to raise money quickly without diluting their control over the company. Once the campaign reaches its target, the startup gives the promised rewards to the investors.
4. Equity-Based Crowdfunding
In Equity-based crowdfunding, investors lend a large amount of money in exchange for a share of equity in the company. Once such a campaign reaches its target, the investors become stakeholders or part owners. Equity-based crowdfunding campaigns are usually used to launch a startup and last a few months to raise larger funding amounts.
The Securities and Exchange Board of India has deemed equity-based crowdfunding illegal in India. It shall remain illegal until a regulatory body is set up for the same.
How does Crowdfunding help startups?
There are a lot of good reasons why entrepreneurs should use the power of crowdfunding for the benefit of their startups. In this section, we will explore a few of those reasons:
1. It lowers the risk
Crowdfunding involves very low risk when compared with the traditional methods of raising funds. The entrepreneurs of the business have a target to meet for their crowdfunding campaign. There are no repercussions if the target is not met. Also, if the target is met, only a nominal fee is charged by the crowdfunding platform and funds are disbursed quickly without any hassle.
2. It protects Equity
This method of raising funds does not dilute the equity share of the founders of the business except in case of equity-based crowdfunding. In reward-based crowdfunding, the investment is made by the public for a reward that they will get if the campaign reaches its target. In this format, equity of the business remains intact and its control is not shared with the investors.
3. It provides validation and social proof
Crowdfunding campaigns can be a window into the minds of potential customers. They can provide social proof towards the relevance and demand of a product. They can give validation to a startup regarding the demand and functionality of the product it aims to launch.
4. It gives an opportunity to refine the business idea
Entrepreneurs can gauge the public reaction towards the product from the crowdfunding campaign itself. This gives them critical input as to what potential customers think about the idea. Thus, crowdfunding affords startups the opportunity to refine their business idea to better suit the needs of their future customers.
5. It is a great marketing tool
A crowdfunding campaign is a good way to market your product and to introduce your vision to the public. It provides your product the media exposure it needs, thus helping it reach the maximum number of potential investors and customers. This also helps create a brand identity and image in the eyes of the public.
6. It promotes Innovation and Creativity
Crowdfunding puts the investors and potential customers directly in touch with the entrepreneurs. They can clearly know what people think about their product or what new features or changes they would like to see. This is a valuable creative input that can help entrepreneurs to innovate and put out a product that is made with the needs and suggestions of customers in mind.
What does the future of Crowdfunding look like in India?
Crowdfunding is dependent on the abundance of internet and social media users for its successful operations. India has the highest number of active Facebook users and the second-highest number of internet users in the world. So, India is a promising market for the future of Crowdfunding.
According to a report, the transaction value of crowdfunding campaigns in 2019 is already 3.7% more than that of 2018. So, the crowdfunding industry is bound to keep growing consistently in the coming years in India.
This will ensure a healthy and hassle-free method for businesses to raise funds for their operations. Businesses can grow better and be more innovative if there are fewer burdens like loan repayment and loss of equity.
Crowdfunding is a well-rounded source of raising funds which also helps businesses gauge product demand and public opinion, find potential customers, and much more. The benefits of crowdfunding for generating funding for businesses are immense. And when compared to other sources of raising funds, crowdfunding, clearly, is the safest and most effective of all.