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Is Crowdfunding the Financial Solution For Your Business?

For years, ICIC has worked with urban businesses – and regardless of the economic climate, one thing seems to always ring true: inner city firms face an uphill battle when trying to access capital. In fact, ICIC research has found that nearly 71% of inner city businesses are undercapitalized compared to industry peers.
In order to reduce their reliance on friends, family and personal credit, many firms have turned to crowdfunding in order to bring their businesses to the next stage of growth.
Crowdfunding, in a nutshell, is the aggregation of funds from a large pool of supporters (or the “crowd”). Donations are made online on some sort of platform. Several forms of crowdfunding exist: rewards-based platforms like Kickstarter provide donors some sort of recognition or reward for donating. Donation-based
platforms like Kiva provide microfinance loans for organizations in developing countries. And more recently, equity-based platforms have emerged to provide larger-scale financing in a way that angel investors or venture capitalists typically would.
Most of you have probably heard the crowdfunding success stories. An entrepreneur comes up with a clever idea and tries to raise $50,000 through an online campaign — but people are so intrigued that the campaign raises more than $1 million. This seemingly “easy” way to raise capital is certainly appealing to inner city business owners, a demographic that usually has to bootstrap to survive.
But as Professor Christian Catalini of the MIT Sloan School of Management tells us, there are both costs and benefits associated with financing your business this way. In a recent CEO Series Webinar, “Crowdfunding: The Good, The Bad, and the Ugly,” he explains in greater detail:
What are the incentives to use a crowdfunding campaign?
• Creators: The main benefit to entrepreneurs, or what Catalini calls the “Creators,” is the ability to access capital at a much lower cost and on a wide spectrum. On Sellaband, the average distance between Creators and Funders was approximately 3,000 miles — more than 86% of funds came from individuals who were more than 60 miles away from the Creator. Another primary benefit is that the Funders can provide feedback to the Creators early on, which allows the Creators to test the market and revise their
product as needed.
• Funders: There are several reasons why people would choose to invest in a crowdfunding campaign. Some are drawn by the early access to products, while others like the recognition that comes along with discovering innovations. Crowdfunding also offers a way to formalize a business relationship with friends and family: those who donate to your campaign have the assurance that if your campaign fails to reach its goal, they will be refunded. Moreover, it provides a way for non-accredited (non-professional) investors to build a reputation for making smart investment decisions.
• Platforms: The emergence of platforms similar to Kickstarter is no surprise; the actual platforms stand to reap real rewards: some firms charge a flat fee based upon the value of successful campaigns (say, 5%) whereas others take home a percentage (10-15%) of revenue based upon future firm performance. On March 3rd, Kickstarter claims to have passed $1 billion in pledges from more than 5.7 million people —
taking a 5% cut on that is no chump change for a company founded in 2009.
So, why wouldn’t someone use a crowdfunding campaign?
• Creators: Perhaps the biggest disincentive for Creators is the need to disclose detailed information on their products, which can include their prototypes or financial records. As such, it opens the company up to competition or compromises its intellectual property if products haven’t been trademarked. Also, Creators might be crowding out traditional investors that have strong industry knowledge, relationships and status. Finally, managing a crowd-funded campaign can be challenging — those that successfully draw attention can receive thousands of inquiries from Funders, which all require responses.
• Funders: No matter how great the concept, the greatest challenge in investing in a product or idea is the ability of the Creator to follow through. A review of 247 successful Kickstarter campaigns found that over 50% of projects were delayed due to Creator inexperience. While fraud has been relatively marginal using these platforms thus far, it’s still another risk that Funders face. Amanda Palmer, a Creator that raised $1.2 million through her campaign to launch her first solo album, is one example of a person who has been criticized for misusing funds.
Crowdfunding is certainly an intriguing concept. Despite its newness, it’s gaining a great deal of momentum. But it’s yet to be seen whether crowdfunding can play any significant role in lessening the capital gap within the urban core. For major change to occur, inner cities need stable, sustainable economic development institutions, such as CDFIs, that understand the challenges inner city businesses face.

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