Over the past few years, the government has made it easier for small businesses to raise money through crowdfunding. But does crowdfunding for small businesses really make sense? I spoke with Stephen Perl, the CFO of PMF Bancorp (USA), to get his thoughts.

What Is Crowdfunding?

"Crowdfunding is basically many people coming together to pay for an idea," Perl explains. He sees that there are two main types of crowdfunding for small business owners.

First, there is perk crowdfunding through sites like Indiegogo and Kickstarter. You can post your business ideas on these sites and ask for donations. For the best results, you could offer some sort of benefit to encourage contributions, for example, a free hat or the chance to buy your product early.

The second option is to try equity crowdfunding through sites like Fundable. On these sites, people give you money in exchange for equity in your business. In this scenario, donors become partial owners of your company.

Crowdfunding Pointers

Before you get too excited about crowdfunding, you should take heed of Perl's warning that most campaigns fail to raise any money. As the CFO points out, crowdfunding only works for companies that can stand out from the competition. "You need a product that will really catch people's attention," he says. "No one wants to fund another toothbrush. Now a toothbrush with Wi-Fi, maybe."

In order to achieve crowdfunding success, you'll also need to create an attractive crowdfunding page with great photos, an interesting story and a reason why people should choose your business over all others. Perl also stresses that you should make sure that your business idea is protected before you publish anything. For example, you should have a patent on your invention. Otherwise, a competitor could steal your idea while you're busy raising money.

The Perk Model Has Potential for Small Businesses

Perl believes that the perk model makes a lot more sense for small business owners. "It can be a great way to market yourself and even attract customers," he notes. "After all, your reward could be that people who donate get the first chance to buy your product."

When you use this model, Perl also points out that there is no limit to how much you can raise per year, there are no prescriptive regulations from the government and you aren't giving up ownership of your business.

The Equity Model May Not Be Your Best Option

Perl does not think that the equity crowdfunding model works well for small business owners, at least not right now. "The government hasn't figured out how to regulate this market yet," he explains. "They require the same financial reporting as major corporations, which is not something a small business owner can easily produce."

Perl also sees too much legal risk with the equity model. For example, if investors don't like how you spend the money, they could sue you.

Even if you overcome these challenges, you can only raise a maximum of $1 million per year with equity crowdfunding. "Business owners might find they are paying out more in legal advice than they raise from equity crowdfunding," notes Perl.

Crowdfunding for small businesses is an interesting idea that will only get more popular as it matures. By keeping Perl's advice in mind, you can figure out whether or not this option makes sense for your company.

Want to learn more about how small business funding has changed over the last decade? Click here.

Tags: crowdsourcing finance