Crowdfunding for startups: the benefits

The crowdfunding-startup pairing has dominated the imagery of this alternative form of financing since its inception. Although history teaches us that crowdfunding originated well before the concept of startups, it cannot be denied that its contemporary fortunes are due to the usefulness of crowdfunding for innovative and non-innovative startups.

This is only natural: startups are the category of companies that have the most difficulty with finding funding and also suffer the most from other resource gaps that crowdfunding can help fill. In this article, we want to precisely answer the question “why is crowdfunding so attractive to startups?”: we will explain what are the gaps just mentioned and what are the benefits of crowdfunding for startups, not only from an economic point of view. Translated with DeepL.com (free version)

But before we proceed, we would like to emphasize that crowdfunding is not only suitable for startups: whatever stage of life a company is in, it can benefit from a crowdfunding campaign (or more than one!). It is, in fact, among other things, also an excellent business development tool. So much so that, while initially the Italian legislation reserved equity crowdfunding only for innovative startups and SMEs, it gradually extended it to all startups and SMEs and finally to all categories of spas and LLCs, regardless of size.

The weaknesses of startups

Startups have inherent characteristics in their very nature that result in certain weaknesses.

1. They need a lot of money, much of which is investment with no financial return in the immediate, and often not even in the future.The startup phase is made up of structures, foundations and indispensable bricks, but also mistakes and repeated adjustments until the business model is properly calibrated. For a startup, it is normal to operate at a loss in the first period, but it needs continuous injections of capital to do so.
2. They do not have metrics: as new businesses, they do not have performance numbers and historicity. To build them, we go back to point 1. But this lack also has other consequences, which we see in the next point.
3. They are not eligible to apply for financing from traditional channels. The lack of metrics and historicity results in the inability to demonstrate their creditworthiness and potential with banks or other lending institutions, as well as to comply with many of the conditions that burden the granting of financing from these entities.
4. They represent a risky unknown. Compared with established companies, they are obviously less attractive for investment because they have a higher probability of failure.
5. They are not only embedded in a network of suppliers, collaborators, customers and other stakeholders, but also competitors. For a startup, the network is critical and must be built step by step from the knowledge of the founders. It is not uncommon for startup founders to already have a valuable entrepreneurial and personal network for the new business, but it needs to be stimulated, nurtured, and channeled toward the new goals. Where there is none, it must be built from scratch.

The strengths of crowdfunding

Crowdfunding has many strengths that can offer solutions to startups' problems and even turn some of the weaknesses listed in the previous paragraph into strengths.

1. It has much less stringent access requirements than traditional funding sources.
2. Allows companies to set their own financing goals and conditions.
3. It enables the targeting of large audiences of potential investors with a single tool.
4. It creates a community around the company, which is a lasting asset and a source of sincere brand ambassadors.
5. It allows you to find both investors and customers in one fell swoop, building or expanding your customer base with solid and lasting contacts.
6. It helps validate the business idea, allowing market testing while raising capital and receiving feedback directly from the target audience of the proposed product/service.
7. It allows the investment risk to be spread over many people and provides a very low minimum investment cut-off, overcoming qualms due to the high riskiness of startups.
8. It improves the startup's reputation towards traditional sources of credit by gaining credibility.
9. It generates visibility and helps the company create its own professional network and reach useful contacts.
10. It is an opportunity for training, skill acquisition, experimentation and restructuring of marketing and sales strategies.

On the advantages of crowdfunding we could go on and on, but we want to focus on those that are most significant and specific to startups. Let us, therefore, delve into the relationship between the strengths of crowdfunding just listed and the weaknesses of startups, clarifying which types of crowdfunding most enable each advantage.

Crowdfunding benefits for startups

Let's start with the most obvious benefit: crowdfunding offers an affordable and democratic way for startups to get at least some of the funding they need, without imposing conditions and requirements that are impossible for a fledgling company to meet. The conditions of a capital increase and share sale (equity crowdfunding), as well as those of selling a product (reward crowdfunding) or the interest rate for a loan (lending crowdfunding) are set by the company itself, which becomes the subject rather than the object of the funding.

As we mentioned, then, crowdfunding is based on convincing a number of people to believe in the potential of a project to the point of investing their own money in it, so it generates metrics: a successful crowdfunding campaign can prove to banks, investment funds, business angels, venture capital that the startup has good potential and has market. Here then crowdfunding becomes a real springboard, both from the point of view of perfecting the business idea and from the point of view of sales and reputation to the outside world.

Speaking of the market, with crowdfunding a startup can test the market by gathering feedback on the product/service and capital at the same time. In this way, one avoids wasting time and money by going directly to market with a product/service that is too similar to something that already exists, or with too narrow an audience, or with incorrect pricing or a lack of essential functionality. A crowdfunding campaign makes it possible to understand if, what, and how much demand there is for that type of product or service and to provide this data as support for demonstrating the company's potential.

Seeking investors brings you in contact with so many people who for some reason have an interest or connection to the company's product/service or its target economic sector: this means accessing so many networking opportunities, using the crowdfunding campaign as a thematic hook and visibility lever, and discovering professional figures or business contacts that can come in handy for the company's growth. Since, moreover, the best investors are the startup's customers or potential customers, crowdfunding means targeting them precisely and turning them into investors and customers in one fell swoop.

Last but not least, for a startup to do a crowdfunding campaign is a great opportunity to gain expertise in different fields, consolidate the team, and to build and test their very own personal marketing strategy to take with them into the future.

Let us now see, in even more detail, what are the specific benefits of the main types of crowdfunding for startups.

Equity crowdfunding for startups

Equity crowdfunding is probably the type of crowdfunding most associated with startups. Not surprisingly: startups are the companies that can benefit the most from it.

As we explored in the Equity vs. Lending article, equity crowdfunding is particularly suitable for startups because it does not require them to demonstrate any creditworthiness. Rather, the selection at entry, which is made by the platforms anyway, is based on the soundness and reliability of the business plan and the context of the target market.

A startup that has an idea with great potential, has carefully researched its feasibility, has drawn up a credible budget and forecasts, is in a growing market with excellent future prospects, thanks to equity crowdfunding can find the first funding to turn that idea into reality.

The shares of a startup, moreover, while having good potential, may not have a very high value, precisely because there are no metrics to evaluate it concretely and there are many unknowns about the future: the affordable price makes it easier to attract investors to buy them in an equity crowdfunding campaign, with the prospect of getting into the business at the right time and then earning money from it once it grows.

It is no coincidence that 62 percent of the companies that did equity crowdfunding last year were startups! (Source: Report 2023 of the Crowdinvesting Observatory of the Milan Polytechnic)

Lending crowdfunding for startups

Lending crowdfunding traces the mechanism of bank lending, but distributes the loan to a multitude of investors instead of just one (or a few) lending institutions.

As a loan, it requires companies that want to access it to be able to back the debt and thus demonstrate a certain creditworthiness. In contrast to equity crowdfunding, in fact, with lending crowdfunding the company makes a commitment to investors, so crowdfunding platforms must verify that it can meet that commitment in order to offer its investors quality proposals.

For this reason, lending crowdfunding for very early-stage startups may be less attractive than other types. It can be a useful opportunity, however, for startups in the Growth stage, which have already started generating revenue and need funding to scale the business, expand, and make the leap.

Another formula of lending crowdfunding that is also interesting for startups is the possibility of using it as bridge funding to obtain liquidity quickly while waiting to release funds from other sources, for example, from a public or private call or capital increase, or from an equity crowdfunding campaign!

Reward crowdfunding for startups

Finally, we come to a type of crowdfunding that is foreign to the category of so-called “crowdinvesting.” In reward crowdfunding, in fact, there is no prospect of a financial return for those who participate in the campaign. The reward is to receive a preview and/or limited edition of the product for whose creation the company has raised the crowdfunding capital.

Reward crowdfunding, then, has many benefits for product startups: it is a low-cost market test that allows them to test interest in the product and refine it by gathering feedback from stakeholders. As well as money to work on the prototype and its refinement: for a product startup, unlike service startups, it is not possible to circumvent material costs even in the early stages.

Not only that, campaign participants will be the product's first and most loyal customers, whom they can rely on for effective word-of-mouth marketing. 

All that is left for startups seeking capital is to discover the full potential of crowdfunding in its various forms and take advantage of all its benefits.