There are an ever increasing number of startups and small businesses looking to raise capital via crowdfunding. You might be interested in crowdfunding because you think it will be easier than raising capital from a traditional source. This may be true, but I am here to tell you that you should not take the crowdfunding process lightly. In fact, many of the current equity-based crowdfunding platforms like MicroVentures, EarlyShares and Fundable put their potential applicants through a rigorous screening process before releasing the investment opportunity on their platform. One area that crowdfunding applicants should pay special attention to is financial projections. Here are 3 reasons why:
1. Can Your Business Scale? – The first reason you need to create financial projections is to determine what happens if you get more pre-orders or more investment than you expected. Many businesses have been using platforms like Kickstarter and IndieGoGo to essentially accept pre orders for their product. The only problem is that you may start out assuming that you will sell 100 units, but then someone with 200,000 followers on Twitter finds your product, sends out a tweet, it goes viral, and the next thing you know you have sold 50,000 units. I think it is worth your time to do some quick what-if analysis with your financial projections and project what would happen financially if you blow your expectations out of the water. Similarly, what if you were looking to raise $200,000 and you have $2 million in interest? Would you accept it? How would you use it? Again, I think it is worth your time to create a set of financial projections that will help you understand what it will take to scale the company.
2. How Much Funding Is Required? – One major risk with crowdfunding is not knowing how much cash you actually need, only getting part way there, and then losing the investment altogether. For example, you might start a crowdfunding campaign and set a goal of raising $100,000. You successfully raise the funds, but then as you get started you realize that you actually need an additional $50,000. If you are unable to raise the additional funds, the entire initial investment is at risk. For this reason, it is vital that you have a clear understanding of your funding needs based on a 12 month cash flow projection.
3. When Will You Breakeven? – You need to know when you will breakeven, and the best way to do this is to create a set of projections. For example, you might have $10,000 in monthly overhead expenses, and you might make $10 of gross profit on each unit that you sell. That means you need to sell 1,000 units per month in order to breakeven. These are numbers that you need to provide to potential equity investors, but you will also want to know when you breakeven if you are taking a pre-order approach. For example, you might want to set up your Kickstarter campaign in such a way that you only produce the product if you get 1,000 orders because you know you will lose money if you only sell 50 units.
Crowdfunding can be an extremely powerful funding solution, but it can also be overwhelming, a waste of time, and ultimately damaging to your company if you do not develop a set of financial projections to prepare in advance. Good luck!
About the Author: Adam Hoeksema is the Co-Founder of ProjectionHub which is a web application that helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.