With multiple ways to fund your startup, the right choice will be dependent on your business plans and goals. Two common sources of funding are angel investors and crowdfunding. While the former relies on individuals or small groups in exchange for equity, the latter pools investors to fund an idea often in exchange for platform fees and a finished product.
Angel investing is a great solution for startups looking to raise significant capital and have an experienced partner/mentor involved in growing the business. Crowdfunding may be right for an idea if the founder does not want to give up ownership of the company and hopes to attract investors more easily. Businesses can also look to companies such as L3 Funding to help with business cash in advance if required. It all depends on how a business wants to operate when they start up.
Every business is different and will require analysis of the options in deciding which is best for the growth and success of your firm. Both options offer plenty of benefits but are accompanied by drawbacks that may make your decision a bit easier. We’ve pulled together the attributes of each option for you to determine what is right for your idea.
Angel Investors vs. Crowdfunding
Let’s first look at what each of these capital raising options is and the benefits and drawbacks to each. Looking at the details is important because your choice could impact the capabilities your business has to make decisions now as well as in the future.
Angel Investors are individuals (or small groups of investors) that provide capital funding for startups and businesses (Source: Investopedia). These individuals typically have a high net worth and have invested in multiple companies in exchange for equity. Depending on the relationship, an angel investor may be hands-on and serve as a mentor to the leadership.
Crowdfunding is the raising of capital from multiple investors, typically via online platforms. Successful crowdfunding is made possible by the sharing of your idea through investors’ networks to raise more money. Crowdfunding campaigns often offer investors perks and may need to produce an end product or reach their funding goal to keep the money (Source: Fundable).
Benefits of Angel Investing
Angel investing is a popular option for many startups, especially among people that the company knows. Personal contacts are typically the first choice for these types of investments because of their trusting relationships and access. With the increased popularity in angel investment, you can rely both on those do and don’t know for capital funding (Source: Entrepreneur).
Angel Investors are Risk Takers
Stats show that only a little over half of startups will survive past year 4, making them risky investments for many (Source: Small Business Trends). Given these statistics, it takes someone who is fairly risk-tolerant to be an angel investor. This is good news for a startup as they can reply on these types of investors to provide them with funding at little risk to the company.
- Angel investors can act more quickly. Using their own money, they can make quick financial decisions and be willing to put forth more capital than a group would. While banks and venture capital are going to want more assurance that your startup is going to be a success, angel investors are providing smaller sums of money and put a lot of trust in a business and its leadership.
- Angel investors have experience in evaluating companies. Many angel investors are serial investors or entrepreneurs themselves, so they would invest in and are aware of the risks. While some risks may be too great for investment, larger business risks (often larger investments) provide angel investors with the opportunity to make a greater return (Source: The Economic Times).
Angel Investors Have Valuable Network and Mentorship
Searching for an angel investor is typically not only for financial gain. Because you are often giving up ownership equity in exchange for an investment, you should look to get added benefit from this exchange.
Some of the additional primary benefits from an angel investor include:
- Experience and business acumen
- Network and contact lists
Angel investors are typically well-connected to other professionals and other angel investors that may benefit your company. Because the investor wants to maximize their returns, they may be more willing to use their resources to benefit the company. You may also give up equity in exchange for a strategic partner who is experienced in running businesses.
Angel investors have your bottom line in mind, and they can be great mentors to help with company decisions (Source: Startup Nation). They may have great experience in your field as well as a strong business acumen that will benefit the future success of the startup.
No Collateral or Repayment to Angel Investors
Unlike a bank loan, you do not have to repay the investor in the event the company fails. This is a great stress reliever for the business in that they do not have to put up any personal collateral or repay the initial investment. This goes back into the risk that angel investors are willing to take on.
Once you have secured the funding, it is also up to your discretion for its use (unless otherwise stated by the investor). This gives you more freedom to make business decisions, ideally with the best interest of all parties involved.
While you are getting money, it is coming at a cost. The equity exchange does mean that you will be giving future earnings to the investor.
Downsides to Angel Investing
Some of the positive benefits can be seen as negative, depending on your goals as a company. Considering these downsides will determine if angel investing is the best solution for your startup.
Giving Up Ownership Equity to Angel Investors
The largest downside to angel investing in the giving up of company ownership. Many investment channels use equity as an attractive exchange because it offers more benefits to the investor, given the risk they take.
Most angel investors seek preferred shares as opposed to common stock to reap greater benefits through dividend profits and an exit (Source: Investopedia) (through mostly through the exit – dividends are much less important in an Angel Investing conversation).
Giving up ownership in a company can be a challenge for founders as they have built it from scratch and don’t want to give up control or potential profits. If you do give up equity, you will want to make sure it is a percentage you are comfortable with. If you give up too much, you may lose control and, therefore, not be able to make decisions that fall in line with your values or preferences.
Increased Pressure from Angel Investors
While increased discipline to satisfy investors and the bottom line could be a benefit, this may also increase pressure on the business. Not fulfilling the expectations of angel investors can put strains on relationships and lead to differences in ideas on how to run the business.
While you may have control, the input is likely to be consistent and very honest from investors.
We like to think of this as a double-edged sword, where this pressure can actually push the business to greater successes, but also create tensions and drive business decisions for profit rather than mission-driven objectives. If your company is strict in its adherence to mission and vision, an angel investor may prevent this.
Compatibility with Angel Investors
Another large challenge associated with angel investors is twofold:
- Finding the right angel investor
- Maintaining compatibility with them.
Given that an angel investor will most likely provide input and be involved in the company as an advisor (to varying levels), a startup wants will want to make sure they are a good fit.
Securing capital is important, but if they own part of the business, it is important that everyone is on the same page. This may include bringing in someone who offers unique strengths to the business, is easy to work with, and aligns with the company on values. Determining the qualifiers for the “right” investor should be determined by the leadership team.
After a company has signed an agreement with an angel investor, hopefully, the conversations you had in choosing the right investor will be maintained long-term.
As business outlooks change, you may find that the relationship and compatibility between the startup and investor change too. This can present great consequences, including animosity between the two parties.
The best way to avoid this downside is to be very selective in choosing angel investors.
This is easier said than done, as many startups do not have many choices in funding. If maintaining control and your vision is important to you as a business, then aligning with investors who are similarly minded will be crucial. This match will also be about identifying the needs and offerings of both sides (Source: Gorilla Capital).
Benefits of Crowdfunding
When discussing crowdfunding, we are referring to the business application. Because crowdfunding has branched off into many types (including personal fundraisers), this distinction is important. Crowdfunding companies such as Kickstarter and IndieGoGo have made this a popular way to raise money for businesses and gain investors far and near.
Simpler Communication and Pitching with Crowdfunding
Unlike the multiple pitches you would have to make to investors on an individual basis, crowdfunding allows you to put all of your information in one place. Your pitch is clearly defined on your crowdfunding site, and investors can make a decision about contributing to your funding goals from that information.
While this method requires a lot of upfront work to clearly convey your business idea and convince investors, this method has the opportunity to save you time in the long run.
Once a campaign has launched and is gaining traction, the site speaks for itself and does not require you to shop around for investors at the same level of angel investing or other funding means.
It is important to note that simply posting on a crowdfunding site will not guarantee views or investments. You should still be reaching out to your networks to attract investment. Less pressure is put on individuals this way as the ask is not solely dependent on an individual, and they can make the investment without pressure and less risk at lower values
(Source: The Money Advice Service).
Significant Funding Opportunity with Crowdfunding
Most angel investments tend to be fairly small compared to those acquired through private equity. The typical angel investment is $10,000, and the average is $77,000 (Source: Small Business Trends). This value may be too small for your startup costs, and that may draw you to crowdfunding. In a 12-month period, a startup can raise $1,070,000 (Source: SEC).
While many crowdfunding campaigns are not seeking this high value, it does open opportunities to get investments from many people, allowing for lots of capital to be raised.
Campaigns that tend to raise these incredibly high values are not only good ideas but have gained visibility and offer important perks to the investors.
Some investor perks that have led to successful crowdfunding campaigns include:
- Pre-orders and early access: Offering your good or service to investors before the public may trigger investment. This would likely be something that is very innovative and highly desirable.
- Interactive experiences: Giving investors unique opportunities to interact with staff, visit the company’s HQ, or go to special events can be a great incentive for potential investors.
- Creative involvement: Investors may really value getting to contribute to the creative process or get involved in the project. They may be investing and have the ability to choose or customize a component to the product or service.
The perks are often associated with varying dollar values, where your greater investments offer more enticing opportunities to investors. Not only are investors contributing to your business to see the final product or service available, but they are receiving a benefit from the investment they make.
Crowdfunding Builds Momentum Through Networks
The opportunity to scale your capital funding efforts through crowdfunding is typically much larger than using angel investors. Instead of securing investments by individually reaching out to investors and relying on their networks for other investments, a crowdfunding campaign can be much more scalable when it gains momentum.
Crowdfunding sites can be easily shared via email and social networking platforms. If you have investors that are really excited about the project and share it, you may get a domino effect of personal networks sharing with each other.
Not only does visibility across social networks help a campaign, but it also provides credibility to a project (Source: Journal of Economics and Management Strategy).
Investors may be more willing to invest in crowdfunding projects they have received through personal or social networks because:
- Trust other investors: If they know other campaign investors, they may have more confidence in investing themselves. This is especially true if they trust the investor and their business acumen.
- Eliminates added research: While good investors do their research into companies, a track record of raised capital for a crowdfunding project helps to establish that a company is legitimate. While there are cases of false positives, an investor can not only feel more confident but partially rely on other investors for doing that research into a good company.
The building of momentum for a campaign could suggest the “next big idea” or serve as proof that there is a demand for a product or service. The more people that get on board for a project, the more money that is raised, and more likely investors are to contribute.
Crowdfunding as a Marketing Tool
Because crowdfunding campaigns are offered to the public, they serve as an excellent marketing and insight tool for your business. Not only are you able to advertise your company to (hopefully) gain widespread recognition and visibility, but investments and trends can help further guide business decisions and dictate the demand for your product.
There are some key elements in a crowdfunding campaign that dictate your marketing efforts as well as expose details about your business:
- Pitch: Your goals and mission should be clearly defined in your pitch on a campaign. This will tell your story and convince investors why they should contribute. Without this clearly defined and communicated, the campaign will not be successful.
- Market demand: If you have taken the necessary steps to properly publicize your campaign and present it clearly, your funding results may help to determine the market demand and validate your business idea. If investment is lacking, this gives you a good opportunity to refine the strategy or product.
- Exposure and publicity: As mentioned, crowdfunding allows you to share your story and be shared across many platforms. People will be directed back to the campaign and can easily contribute.
Marketing is not only the publicity of a product or service but all the processes and institutions in place that go into creating and offering your idea to the end-user (Source: American Marketing Association). A crowdfunding campaign allows you to pin down all areas of the business from creation to execution and convey those ideas for potential investors.
Downsides to Crowdfunding
While there are multiple benefits to crowdfunding as an investment source, you should also be aware of some of the drawbacks to this method.
Crowdfunding Fees and Expenses
Crowdfunding will require some spending to make the most out of the platform as well as have access to it.
When raising money using a crowdfunding site, you will be expected to pay fees on your fundraising goal. If you need to raise a certain dollar value for operation, we recommend shooting about your goal by 3-5%, as this is what most of the sites will charge (Source: The Balance Small Business).
Not only do most platforms take a percentage of earnings, but there is usually a fee per transaction as well. This is a flat rate that is charged for every investment received. With many small investments, this value could add up.
You will want to consider these fee structures before you choose to use crowdfunding. While it is a small percentage, this can be a considerable sum when you consider your overall goal. For crowdfunding platforms, you should look into:
- Transaction/processing fees: Credit cards are charged flat transaction fees and covered by the campaign.
- Platform fees: Some sites may require one-time fees for platform use.
- Commission: Sites charge 3-5% depending on how your campaign is set up.
- Marketing and production fees: Great crowdfunding campaigns usually have a robust site and produced video content to share their idea or story. Conversion rates into customers (or investors) increase by up to 80% when videos are included, especially good ones (Source: Entrepreneur).
Factor these costs into your overall budget to see if crowdfunding is the ideal option for your business.
Crowdfunding Sets Timelines
Many crowdfunding sites will set a timeline for the duration of your campaign. These sites have done the research and found that shorter campaigns are typically the most effective (Source: Kickstarter). Popular sites such as Kickstarter and Indiegogo set a maximum campaign run time at 60 days.
For a business, setting an allotted amount of time for raising capital may be a challenge. It forces you to plan carefully ahead of time and make sure you are able to successfully publicize your campaign early. This added pressure may not be the best fit for your individual firm and strategy.
Crowdfunding Requires Additional Marketing and Preparation
When you run a campaign on a crowdfunding site, the responsibility of marketing the campaign falls on you.
Unless your campaign is trending (which is usually due to successful marketing efforts), it will not be featured on the site. This means that substantial preparation is required to ensure that your launch will be a success.
Months of preparation are required to produce a successful campaign, which extends far beyond your business plan. These are some of the important plans to consider:
- Video production: Strong videos convey your ideas much more easily than words for many projects. Investing in a high-quality video will have a much greater impact than a home-video, which may convey a lack of professionalism.
- Social media strategy: Targeting specific groups that would benefit from your idea and using the right platforms to connect with them is important. The messages you send should be effective and entice viewers to invest.
- Press releases and website: You should make sure your website is well-established with clear information and media to get picked up by other outlets.
- Consistent updates: Successful campaigns update their investors on funding milestones as well as company and idea updates. Keeping investors involved in the process will benefit you for further investment and continued excitement around the project.
The better your preparation is, the more successful execution can be. It will help to foresee challenges you may face and have back-up plans and strategies to drive further investment.
Building Trust Is Required with Crowdfunding
When approaching an angel investor, it may be a little easier to gain investment because you might know them. With crowdfunding, you are relying on many people you don’t know to fund your business idea. It can be a challenge to build trust with investors, especially when crowdfunding campaigns do not always fulfill their promises to campaign backers.
While building trust can be difficult, there are steps you can take to put yourself in the best possible position:
- Be transparent: Communication is very important in conveying your message and intentions for investment as well as updating investors throughout the campaign. This may include updated videos of what the company is working on, social media posts, and contacting individual investors.
- Show tangible evidence: For products, having a prototype is key for investors to not only understand how the company works but show that there is a physical product that will be available. For services, evidence of impact can also be shared.
- Social media and website: The more legitimate your business appears, the greater trust you will build. Having a well-designed website with all necessary information and updated social media helps investors build confidence in your brand (Source: Two Feet Marketing).
Determining Whether Angel Investing or Crowdfunding is Best
Given the information presented, you probably have a clear idea as to which financing option is right for your business idea. Both can be excellent choices depending on the direction you plan to take your business.
Here are the situations in which you would benefit from using an angel investor:
- Gaining mentorship and expertise from angel investors is an added benefit.
- Capital is guaranteed in exchange for equity as in crowdfunding; you may not keep it if the goal is not reached.
- Working with only a few investors is easier than being liable to fulfill commitments to many in crowdfunding.
Here are the situations when you would benefit from crowdfunding:
- You do not have to give up any equity in crowdfunding.
- Promoting your product or service is part of a crowdfunding campaign and can help you to scale the investment as well as future customers.
- Crowdfunding can be used as a marketing tool to better understand market trends and future growth.
It is important to consider which type of funding source to use based on your specific business plan as well as the current situation you are in with resources and financially. You will want a situation that not only makes the most sense for your business now but more importantly, the future growth of your startup.