Ever since the JOBS Act was introduced by president Obama, about a year ago, crowdfunding has become all the rage for many new ventures. The JOBS Act was established to help start-ups raise capital so they can go public; it also recognises the “new” form of capital raising, known as crowdfunding – an easy way to raise funds while bypassing the risk-averse financial institutions. However, just like any other financial market transaction, there are advantages and disadvantages to this ‘fashionable’ method of raising funds.

So what is crowd-funding or a.k.a. crowd-sourcing?

It simply means that you source funds from the public using websites such as Kickstarter. The internet has made this concept very easy to execute; however traditionally it was done via benefit events, mail-order subscriptions and other.

Imagine you have a business idea. You can pitch your idea on crowd-funding websites and if people want to support your campaign, they can donate money to help you bring your idea to life. You can also offer incentives or discounts of your future product once it is produced and ready to be sold.

This all sounds easy; but there are both advantages and disadvantages of raising funds this way.

Let’s begin with the positives:

  • Huge positive with crowd-funding is that you have validated your customer base who are ready to buy your product
  • You also have a great opportunity to interact with your customers who are also investors in your idea; you can also seek feedback from them during the development and the testing stages
  • These customers/investors can also be a form of advertising for you, i.e. free word-of-mouth advertising
  • Unlike venture capitalists or other professional investors, you don’t have to give up equity in the business, and you still own your business in full
  • Low risk
  • And if you don’t achieve your ideal target figure, you don’t have to commit.

While this all sounds fine and easy to do, this type of capital raising is “new” to many, and like many financing options out there, it does have its fair share of challenges. I’ve listed some of them here:

  • You can put all the effort into your pitch, but there is no guarantee that you will reach your funding goal in your preferred time
  • You need to be great at presenting your idea and product, so that people can buy into it
  • It can be time-consuming as you may need to spend time with your backers; they will ask a lot of questions, and constantly seek updates on the progress of your products
  • Be prepared to offer rewards or incentives to your backers
  • Crowd-funding is competitive and you have to compete with other folks who are pitching completely different ideas to yours.

There are also other challenges such as regulations that were introduced specifically to curb the crowd-funding mania. There are financial obligations attached to crowd-funding such as compliance reporting and disclosure requirements; there are legal liabilities to consider; and, a recently introduced maximum cap of $1m in a 12-month period can prove crowd-funding may not be the most cost-effective capital raising option for some hopeful entrepreneurs.

So if you’re considering crowd-funding as your funding strategy, my advice is to be well prepared and of course, always seek legal advice.