External sources of finance come from outside the business. Crowdfunding belongs to external sources of finance. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance.
The amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively low value such as vehicles will be small. While the amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively high value such as new machinery for the assembly line will be large.
2. Crowdfunding
Crowdfunding is the use of small sums of money from a very large number of private individual people to finance a new business venture. Usually, sole traders and partnerships will use crowdfunding as a source of finance for their start-ups.
How does crowdfunding work?
Crowdfunding is usually done online through websites including Kickstarter, Indiegogo, Crowdcube, Patreon, GoFundMe, CircleUp, Crowdfunder, Fundly, Mightycause or SeedInvest.
These crowdfunding websites allow small entrepreneurs to promote their new ideas to millions of people who might be willing to invest small sums of money such as USD$10 or USD$20 or USD$50. Investors will keep on committing those small sums of money until the expected by the particular entrepreneur target sum of money is reached.
Through these established websites, entrepreneurs will explain what their businesses are all about, what products they offer, what their business objectives are, why they need finance, etc.
If the new business venture is successful, crowdfunding investors will receive their initial capital back with interest, or an equity stake – meaning a share in profits.
Why would businesses use crowdfunding?
Crowdfunding is a significant source of finance for new business start-ups. New entrepreneurs rarely have sufficient finance to set up their own business. Banks may not be willing to lend money to entrepreneurs with no proven success record, or interest rates on loans to those entrepreneurs might be very high.
Small businesses using crowdfinance benefit from the capital that would otherwise have been difficult to obtain from traditional sources.
However, they must keep accurate records of thousands of investors to either pay back interest and capital, or a share of the profits.
Why would people participate in crowdfunding?
Investors hope to make a return on their investment. However, if you plan to become a crowdfunding investor, remember that the failure rate of newly created businesses is high. As many new companies fail, you may not receive any returns at all.
Some social enterprises may not aim to make large profit, or any profit at all. In this case, you will be just donating money to a social cause.
