Crowdfunding or a Small-Business Loan: What's Best for Your Company?

Get the working capital your business needs from Entrepreneur Lending, powered by CAN Capital. Learn More »

The crowdfunding site Kickstarter might be best known for funding films, games and products -- like Pebble, the Palo Alto-based smartwatch whose maker raised more than $20.3 million in March, making it the most-backed product in the site's history.

But occasionally, small Main Street businesses get their start through crowdfunding. One example is Portico Latin Bistro & Cantina in Langley, Wash., on rural Whidbey Island near Seattle, which raised $16,000 in seed money late last year.

Owner Graham Gori was skeptical about his chances for success, and he was right to be: Although Kickstarter has raised $1.8 billion for projects since 2009, most campaigns — about three of every five — fail to launch. Chances on Indiegogo, another crowdfunding site, are even slimmer; about 1 in 10 fundraising projects reach their goal. And small businesses have the toughest time: Only 3.1 percent of small-business projects out of 20,000 reached their goal on Indiegogo last year, according to reports.

Related: 4 Tips to Set You Up for Crowdfunding Success

Is crowdfunding right for you?

At NerdWallet, we examine complex financial situations that could affect small businesses. We then try to reduce them to a few key drivers to help bring clarity to the financial decisions people may make.

We found that successful crowdfunded projects or businesses depend on two main drivers:

  1. You must have a sexy, marketable project or product.
  2. It's crucial to have a large number of backers -- friends, family, local community, existing online followers -- who are willing to drum up support for you. These people are your funders, but they are also your promoters.

It's not enough to satisfy these drivers, however; you must also have a high risk tolerance. It’s an all-or-nothing mode for Kickstarterl: If you fail to reach the fundraising target you’ve set, you get nothing. In other words, you could spend weeks raising money on Kickstarter and lose it all if you don't meet your minimum threshold.

Other crowdfunding sites are not all or nothing, but they can still leave business owners facing considerable uncertainty.

How a small-town business succeeded

Gori built a successful Kickstarter campaign by:

Testing the market. While Gori was “no expert on Kickstarter,” he did need to figure out if a campaign would even have legs, so he had to determine if there was a need in the market for his kind of restaurant.

Related: Cash Crunch: What's the Best Loan for Your Small Business?

“I set up a stand at a holiday bazaar over Thanksgiving weekend at a local farmers market. We prepared blue corn pozole and vegan pipian rojo, put up a little stand and hung up our shingle,” he says. People lined up for his fare. “There was clearly an opening in the market for what people here would call ‘ethnic food."

Mobilizing friends and family. With 17 days to run his campaign during the busy holiday season last year, the first step was getting help with a promotional video.

"I called a friend who was a photographer. He said, ‘I’m booked for the next two weeks, but I’m free tonight.’ We borrowed a friend’s house with an enormous kitchen, invited a bunch of friends to take part. We did it in two takes.”

Doing some old-school marketing. While Gori took advantage of a cutting-edge funding platform and all the social-media tools at his disposal, he also used one of the world’s oldest marketing techniques: He put on a sandwich board and walked in a parade and at a school festival, passing out fliers.

“A local magazine and newspaper did articles on our campaign. Folks at the library helped me create fliers with tags, like you see for garage sales,” Gori says.

In small communities, especially places like Whidbey Island, where one in five residents is above the age of 65, you can’t expect your market to be glued to social media for outreach.

The alternatives to crowdfunding

If you’re a startup business -- say, a franchise -- you may have easier access to credit on manageable terms than you realize. Your franchisor is one possible source, and small-business loans may be available from other lenders if the brand you’re franchising has a strong track record. Another place to try is online lender Funding Circle, which has agreeable terms for franchises.

If you’re opening a business with low overhead costs -- like a consultancy or graphic design company -- and all you need to start your business from home is a computer and an Internet connection, business credit cards may be all the capital you need.

If you have good credit, another alternative to crowdfunding might be a personal loan or, if you own a home, a home equity line of credit.

Small companies in business-to-business industries with invoices and low revenue -- essentially a cash flow problem -- may want to consider selling accounts receivable, a small-business financing technique known as "factoring." BlueVine, Lighter Capital and Fundbox all have products that can help.

If you have no invoices, low business revenue or low business credit, online lenders like OnDeck and Kabbage may be good alternatives to crowdsourcing and traditional bank loans. 

Related: Applying for a Short Term Business Loan Online? These 4 Steps Can Protect Your Startup.

Small businesses that have been around for longer than two years have more options. If you have a high credit score and are picky about what kind of debt you take on, you should investigate SBA loans from traditional lenders or new lenders. These government-backed small-business loans have significantly lower rates than many other lenders offer. Alternatively, you can check out online lenders such as Funding Circle, Lending Club and Fundation (if you have two or more employees).

Have a backup plan

Even Gori didn’t rely on his Kickstarter campaign alone to succeed. As a backstop, he applied and received a $15,000 loan from Whidbey Island Local Lending (WILL), a group that matches local investors with local small businesses in search of funding.

The Portico Latin Bistro & Cantina campaign defied the odds, but it was a nail biter. Gori — a former correspondent for The New York Times and Associated Press in Mexico and Central America, whose love of Latin food turned him into a chef — only succeeded in meeting his goal in the last hours of the campaign.

“There was a sense of relief, just my wife and I in an empty bedroom looking at the computer screen,” he recalls.

Crowdfunding can be a fun and successful way to fund your small business and generate buzz even before you open your doors. But it’s important to explore every available option as you look for the small-business funding. Although the crowdfunding route isn't easy, you may find success and blow past your intended goal. But just remember to have a backup plan.

Related: Why Now Is the Best Time to Start Your Own Business