The financial winter of 2008-09 seems really far behind folks in the rearview mirror but it had a lasting effect on how small businesses could get credit and operational financing. After that moment of almost an entire seize-up of the American financial system, the means by which business credit could be obtained changed dramatically. Dubbed “peer lending” and “crowdfunding”, respectively, micro and small-businesses realized they had an additional opportunity for startup funds that didn’t exist before. No surprise, today these tools are often touted as great tools by entrepreneur talk sites, videos and blogs, and they can provide some means to immediate cash with very few strings attached. However, from an ongoing, long-term capital perspective, crowdfunding has a lot of weaknesses that make it unreliable as a serious operational financing tool.
First off, there’s always a big question how long a financing venue will be available in the hyper-speed startup and failure rate of Internet businesses. And that raises a big concern as to whom one will end up owing money to whom when financing is provided in the form of credit. Sudden changes in payback terms can create nightmares for fragile businesses.
Second, the reliability of crowdfunding is really, really spotty, and that doesn’t work well when a business needs financing, credit or cash by deadline specific. For crowdfunding to work, it depends on what is known as online “viral” attention. The business has to literally make a pitch online to attract attention and get people to provide either crowd-combined lending or similar in outright cash contributions. It is possible to realize large sums through these tools, that much is true (film producers for example have funded movies with crowdfunding). But the timing of when cash arrives, and how much is actually realized is literally a guess. Worse, sometimes the money just doesn’t happen, period.
Third, the crowdfunding world is really crowded, no pun intended. Wherever there is the ability to get free cash or very liberal credit there’s a whole lot of folks with ideas. And that tends to dilute the need of a given business because the company’s pitch gets lost in a sea of lots of needy people online. To see how many, just go to any crowdfunding site and search for a given topic like “starting a business” or “new project.”
Fourth, crowdfunding functionally works better on a specific project basis versus a rolling or cyclical need like supply or payroll. Because the timing of when cash arrives, if it does, is so unpredictable, one-time project fundraising campaigns work much better as the crowdfunding support can be combined with other resources by deadline certain versus being relied on as working capital. In fact, if a company tries to rely on crowdfunding monthly, there’s a good chance it will go bankrupt first.
Crowdfunding can provide some helpful, rainy day funds, but it has no place in business cash flow an ongoing operation. Treat it as a bonus versus a dependency.