MaRS Library Crowdfunding campaigns: Risks for startups
Many startups have come to consider crowdfunding as the solution to their fundraising woes. Despite inherent risks, startups often choose to leverage a pre-sales or donation-based crowdfunding campaign model.
Why take the risks? A successful crowdfunding campaign can yield more than fundraising. It can:
- Generate a large amount of free publicity
- Recruit many advocates for the venture
- Provide founders with rich market feedback on their product or service
But crowdfunding risks should not be overlooked. Campaigns are labour intensive and the majority of campaigns fail. Do not think of it as easy money. While startups can manage and mitigate some of the risks, keep in mind that crowdfunding is not for everyone.
We explain six common and serious crowdfunding risks below.
Crowdfunding campaigns: Six common and serious risks
Risk #1: Launching the crowdfunding campaign too early
Startups must get to know their market before launching a crowdfunding campaign. Specifically, they must understand who their target market is, what motivates this market to engage with their product/brand and how to best communicate and engage with them. Even though some crowdfunding platforms may bring funders beyond the startup’s own network to the campaign, startups should plan on having to bring all the backers needed themselves for the campaign to succeed. This means that a solid social network should be built before launching. Crowdfunding veterans frequently cite network benchmarks as requiring at least 1,000 named targets, with 30% having committed their support before the campaign launch. Getting to those numbers may take longer than anticipated. In general, we recommend that startups not launch their campaigns until they meet these benchmarks.
Risk #2: Underestimating the work and time required to manage a fundraising campaign
Anyone who has run a crowdfunding campaign will tell you this: once you launch the campaign, it is all-consuming. The work involves generating momentum by tweaking and launching new perks, responding to questions and suggestions from supporters, keeping social media activities running and trying to win mainstream press coverage. Until your campaign target is within reach, the pressure is on constantly to do more of everything.
Risk #3: Missing the price point
For startups planning a pre-sales campaign, missing the price point that will generate the most sales is a significant risk. Put the price too high, and you risk selling less than required to reach the campaign target. Put the price too low and you “leave money on the table,” while risking not being able to cover the cost of fulfilling the order. The best way to avoid charging the wrong amount is to vigorously pursue the 30% pre-campaign support as mentioned in Risk #1. This direct customer engagement will allow you to repeatedly test and obtain feedback on your price points and revenue model.
Risk #4: Underestimating the cost of fulfillment
Without reliable and accurate cost estimates, it is impossible to set the right price for your pre-sales campaign. In your cost estimates, include contingency plans for replacing key suppliers or components in case your supply chain fails to deliver. Evaluate whether your estimates cover your costs in a worst-case scenario. If you run a successful campaign, failing to deliver on the promises you make to campaign backers can ultimately lead to a class-action lawsuit and bankruptcy.
Risk #5: Selling a product that is a poor fit for crowdfunding
Not every product or service is a good fit for crowdfunding. Ultimately, a key objective for any crowdfunding campaign is to create support and engagement from an enthusiastic network of supporters. However, certain types of products and services hold less appeal in a crowdfunding campaign than others. In general, products and services that are intended for business use have a harder time getting crowdfunded than consumer-facing campaigns.
The average contribution for most crowdfunding campaign is roughly $70. For every dollar above $70 that you solicit, fewer people will consider supporting your campaign. Many campaigns mitigate this problem by offering less costly tokens of appreciation for smaller contributions. A pre-sales campaign for items priced at $5,000 or more risks facing significant headwinds because the cost lies beyond the comfort zone of many funders. That said, numerous campaigns have been able to solicit individual contributions of $10,000 and more by assembling creative perks. This goes to show that nothing is impossible in the quickly evolving world of crowdfunding.
Risk #6: Running afoul of the crowdfunding platform rules
Campaigns that run afoul of the fundraising terms and conditions of their crowdfunding platform may have their campaign suspended. Or they may face difficulties in accessing their funds, even if the campaign meets its targets. Either scenario is obviously adverse, so before launching your campaign, ensure your team reviews its plan against the platform’s rules. Doing so can help startups avoid this type of monetary and reputational distress.
Note: This article pertains to crowdfunding involving pre-sales and donations. Other risks arise with equity crowdfunding, which as of 2013 is not legal in Ontario.
Crowdfunding now, but interested in learning more about preparing for angel and venture capital investment? We’ve created a free online course to help you get investment-ready. Check out Introduction to Investment Readiness and learn useful tips, tactics and strategies to prepare for your seed fundraising round.
Steinberg, S. (2012). The Crowdfunding Bible. Retrieved December 8, 2013, from http://www.crowdfundingguides.com.
Hart, L., Pillai, S., Tyler, S. & Wicks, M. (2013). Is Crowdfunding Right For You? Toronto: India Innovation Institute, University of Toronto.