In the realm of startups, there is no shortage of great ideas. However, concepts with the potential to be profitable require funding to develop and market the idea. There are many different forms of investment that founders can seek in the early stages of their company. Typically, founders have the option to choose between crowdfunding and traditional forms of investment. Although crowdfunding has increased 33.7% in the past year, your company may be better suited for a small business loan or the assistance of a venture capitalist firm.
The best investment strategy for your business depends upon your unique goals and aspirations. If you are in the early stages of development and currently seeking funding, this post clarifies the different forms of investment and situations in which each one is most useful.
What Is Crowdfunding?
Many entrepreneurs are familiar with the term “crowdfunding” concerning raising capital for a successful company. It is when entrepreneurs garner funds from large groups of people in the form of multiple small investments. These funds are typically allocated towards startup costs and campaign creation. What makes crowdfunding unique from other forms of investment is that it requires the engagement of so many people. It provides an incredible opportunity to raise brand awareness when your company is in its early stages.
Crowdfunding is not limited to product-based businesses; it can also refer to raising funds for services, art, community ventures, and more. Crowdfunding provides entrepreneurs with the resources they need to generate funds and market their concept to the public. With the support of crowdfunding, you can garner demand for your products and services before they have officially launched.
In the past, entrepreneurs raised capital for their business ventures with loans, friends, family, and venture capitalists (VCs) or angel investors. However, in the late 2000s, crowdfunding became a viable option for entrepreneurs to get their projects off the ground.
What Is Traditional VC Funding?
Traditional venture capitalist funding is when an individual or company uses conventional sources to raise funds for their startup. For traditional fundraising, an entrepreneur raises capital from banks, charitable foundations, government agencies, and high net worth individuals rather than seeking resources from the public.
Unlike crowdfunding, the traditional funding you acquire isn’t considered a charitable donation. When an investor provides you with funding, they own shares of your company in exchange for your investment. Essentially, this means that if you were to sell 10% of your shares to investors, 10% of the profits that your business accrues would go directly to the investors.
Companies that seek traditional VC funding typically go through this process many times, and with each round of funding, they give investors more shares of their company. This funding option is an excellent choice if you are comfortable relinquishing a portion of your profits and control over your company.
Which Option Is the Best Choice for Your Business?
Different Types of Crowdfunding
Effective crowdfunding requires the fulfillment of three main roles, including the project initiator, the investor, and the intermediary. The project initiator is the individual who conceives the idea for the company, while the investor is an individual or organization that further develops the concept. The intermediary is the website that assists the project initiator in contacting investors for the company.
There are three categories of crowdfunding:
- Donation-Based Crowdfunding is a campaign in which the investors do not receive a financial return.
- Reward-Based Crowdfunding occurs when people invest funds into a project to receive the product or service that the company provides. Reward-Based crowdfunding is a subtype of donation-based crowdfunding because the investors do not receive a financial reward for their contribution.
- Equity-Based Crowdfunding is when the contributors become partial owners of the company in return for their investment. The funds that they invest provide them with an equity stake in the company.
Benefits and Drawbacks of Crowdfunding
New business ventures often face difficulties accruing funds in the early stages of development. Most lack the potential for a high return on investment in the eyes of VCs, and obtaining funds from banks can be extremely challenging at the start of a new business venture. Crowdfunding makes it possible for entrepreneurs who don’t have access to more exclusive financing methods to kickstart their business.
Furthermore, crowdfunding campaigns pique the interest of potential clients or customers. The number of people contacted alone increases brand awareness and allows entrepreneurs to reach people who can become brand ambassadors. Additionally, crowdfunding enables entrepreneurs to have more creative control over the company since the investors do not have a stake in the company as they would with traditional forms of investment.
While crowdfunding has its benefits, there are risks involved with any form of investment. To start, if the company fails, investors will lose every dollar they invested into the company. Even companies that meet their crowdfunding campaign goals run the risk of failing miserably. For entrepreneurs, it often takes tens of thousands of dollars to create a successful campaign. In addition, there is always the risk that someone could steal your ideas, and there is no guarantee that your crowdfunding campaign will reach its goal.
Different Types of Traditional Investment
There are many different traditional investment models, and choosing the right one for your startup is a highly personal decision. Although each type of traditional investment will allow you to raise the necessary funds to get your business off the ground successfully, each investment form has specific stipulations. Three of the most common types of traditional investment include the following:
- Small Business Loans are akin to personal loans in that they require an established line of business credit to obtain. Furthermore, acquiring a small business loan entails that you’ve received an established amount of funding, along with the interest rate.
- Venture Capitalists are typically members of a venture capital firm. A venture capitalist (VC) is a private investor that invests in startup companies. If a VC offers to fund your startup, they expect a payout when your business is successful. If your company fails, the VC does not receive any financial compensation.
- Angel Investors are individuals who have the finances to invest in up and coming businesses. They are typically not connected to a firm or board. Angel investors receive compensation in the form of equity or ownership of your business.
Benefits and Drawbacks of Traditional Investment
Traditional VC investments are arguably the best course of action for startups that favor rapid growth and would like to scale their company quickly. Additionally, venture capitalists offer valuable advice to help expand your company while connecting you with top talent for your team, potential business partners, and investors that may provide you with funding in the future. The increased funds that you acquire can also simplify your hiring process and reduce the risk of failure.
Although 20% of startups fail within the first year, traditional venture capital investment dramatically decreases this risk because you will have the guidance of experienced investors who can help you navigate difficult situations. When a venture capital firm invests in your company, it also eliminates the need to make monthly payments on a business loan. Due to this, you will be able to invest capital into expanding your company. Furthermore, you will not need to pledge your personal assets to acquire funding. Since most venture capitalists have access to PR groups, they can increase your startup’s exposure.
However, traditional VC investment may not be the best choice for your company if you are uncomfortable with giving up a portion of your decision-making power. In the early stages of a business venture, founders are typically preoccupied with ensuring that their operations go smoothly. As a result, founders may not have the time or energy to convince VC firms that their company is worthy of investment. Lastly, traditional VC investment is highly challenging to obtain in the first place. Many venture capitalists state that they often receive 1,000 proposals for every three or four startups they invest in.
Fahad Alrajhi Group
It takes time and careful consideration to discern which form of investment is appropriate for your startup in the early stages of development. Is your business prepared to expand? If you’re seeking venture capital, consider contacting Fahad Alrajhi Group.
Fahad Alrajhi Groups seeks to endorse a culture of entrepreneurship and invest in business ideas that radically impact society while diversifying regional economies. If you have an exciting business that aligns with our values, please contact us today.