There’s a right way to approach crowdfunding, and a whole lot of wrong ways. Some of those wrong ways could lead to litigious customers, fines, and even criminal charges. So let’s talk about avoiding the most common mistakes entrepreneurs make when considering crowdfunding.
Crowdfunding is a welcome phenomenon in the startup universe. When I began my career in startup over 20 years ago, raising money was next to impossible unless you were tied into venture capital in Silicon Valley or New York, maybe Boston.
The contrast between then and now is stark and unquestionably positive for the entrepreneur. However, just because there are more VCs around with more money to spend doesn’t mean everyone gets funded. There are still way more investable startups out there than investment dollars.
Thus, the democratization brought about by crowdfunding is a net positive for the entrepreneur, but it has, of course, led to misunderstandings, misuse, even misappropriation — mostly because of misconceptions and mistakes, and there are plenty of those.
So here’s a look at some common crowdfunding mistakes that I’ve seen entrepreneurs make and what to do instead.
Don’t Mistake Crowdfunding as VC-Lite
The first and biggest mistake entrepreneurs make with crowdfunding is the misconception of crowdfunding as a substitute for institutional capital. In other words, founders decide that they’re not getting traction with VCs or angels, so they turn to the crowd as an easier (sucker) target.
Don’t do this.
If the financial requirements of our startup fit the VC/Angel model, we need to be seeking VC/Angel investment. Crowdfunding is not VC/Angel with a lower bar for investability, and if our fundraising efforts are striking out with traditional investors, the prospects are going to be no rosier with the crowd.
We need to determine our funding model up front, and make sure it fits our business model. VC/Angel funding and crowdfunding are similar, for sure, but they’re not the same. There are several key differences that we need to take into account before we begin raising.
Don’t Mistake Equity for Product
First let’s keep ourselves out of financial and legal trouble.
There are basically two types of crowdfunding: Investment Crowdfunding, which is selling equity in the company, and Donation and Rewards Crowdfunding, which is selling product or goodwill to early adopters. These are two completely different schemes with completely different requirements.
I’ve dabbled as both an angel investor and crowdfunder, but mostly I start and grow companies. So I turned to a former investor in one of my startups who also led the Investment Crowdfunding regulatory push in North Carolina where I’m based. Mark Easley now runs CrowdFundNC.com.
“When we are talking about Investment Crowdfunding, it is important for founders to remember that they are selling securities, either equity or debt, which are regulated at either the federal or state level depending on which exemption is chosen.”
The process for Investment Crowdfunding is a lot like traditional fundraising. There are regulations, restrictions, rules, and exemptions. For example, we still need to file our Form D, or something like it.
Mark says, “The filing, disclosure, and promotion rules vary depending on the exemption. So founders should understand the rules and get good guidance on following them from their investment platform and legal team.”
Don’t Go It Alone
Whether we use the Investment or Donations and Rewards model, another big mistake founders make is assuming the crowdfunding process is self-fulfilling. But we can’t just open the funding door and count the money as it comes in.
For Investment Crowdfunding, as Mark suggests, having financial and legal experts, either individually or through a platform like the one he runs, is critical, not optional. Selling stock to the crowd is not a simple or short-term process, and we’ll need to shepherd that process all the way to the end.
For Donations and Rewards Crowdfunding, we’ll be embarking on a different kind of journey, but one that can be equally resource intensive. Like all startup investment, we’ll want to be raising money to complete and deliver the product, not start from scratch. So we’ll need to have identified the right makers and sellers for our team and have a minimum viable product for them to button up and ship.
In addition, we’ll also need to identify a marketing team and plan a number of crowdfunding campaigns, as D&R is more marketing than fundraising.
Don’t Use Crowdfunding To Market Test
This is a common misconception with all forms of fundraising but it especially applies to crowdfunding: We should never raise money to validate an idea or a product with the crowd.
Even if we get funded, it’s dumb money and it will usually lead to trouble. But it’s more likely that we won’t get funded, even for and especially for Donation and Rewards Crowdfunding. This is because, unlike traditional marketing campaigns, the results of a D&R campaign are pretty much all binary, we either hit our goal or we don’t.
Thus, we need to campaign on the exact right product for the market to provide the best chance at hitting our goal. We also need to be marketing exactly what we’re going to ship, so we won’t be setting the wrong expectations for our backers.
Now, let’s apply the market-testing scenario to Investment Crowdfunding and we’ll immediately see the flaw. We have investor #1 who thinks of our company a certain way, but by the time we get to investor #100 our model, maybe even our company, has evolved dramatically because we followed the money.
That’s how lawsuits happen.
Don’t Expect Your Startup to Fund Itself
We entrepreneurs do this all the time — we prep the channel, we open the channel, we sit back and wonder why no one is buying. Both Investment and D&R crowdfunding take a lot of work, just like a roadshow, to get to the goal.
One D&R campaign I like a lot is Joeveo, a startup that bootstrapped its way to their first product, a scientifically engineered mug for coffee and tea enthusiasts. Once they had their MVP, Dean Verhoeven, the founder, decided that D&R Crowdfunding was the right path for Joeveo.
“We used Kickstarter to crowdfund initially, with a home-made campaign.”
But the sales did not roll in overnight, nor did the campaign follow what anyone would call a common and repeatable path.
“It succeeded because of ‘organic’ marketing. I was working with a recent NC State grad and the campaign was picked up by the school newspaper, and my nephew pitched it to a big tech podcaster he knew who talked it up on his show. These mentions were picked up and amplified by other big tech/gadget blogs. We got no results from paid PR, though we didn’t spend much on that route.”
Lesson learned: Crowdfunding is not a substitute for marketing. Or legwork. And the difference between success and failure might hinge on constant contact.
“Communicate with your backers,” Dean says. “They will love you for it.”
Don’t Rely on the Wisdom of the Crowd
Any institutional investor will tell you that they bring more than just money to the table — they bring experience, connections, and a guiding hand. While I don’t think of this as a panacea, it’s something valuable that we’re not going to get from the crowd.
No matter which crowdfunding model we choose, we should have our board and our advisors in place or at least be thinking about it.
We may run into a situation where a plurality investor might drop hints or even demand a board seat. Ownership does indeed imply board membership, but diluting the shares across such a large number of investors is going to open up a can of worms in that regard.
My preference would be to have a board selected, even make it public, before the fundraising begins. Investment Crowdfunding is usually a stepping stone to a more traditional fundraise, and more permanent board seats can be defined and filled at that time.
Of course, in the D&R model, a backer should never be a board member, because they don’t own equity, but the same advice applies.
Before we consider crowdfunding, as with everything in startup, we need to be thinking about tomorrow today. Being prepared for what the company looks like after a crowdfunding raise is critical, because we never know what kind of crowd we’re going to get.