Community-sourced Investing: Should You Fund Capital Improvements?

“But, is it a good idea to invest?” asked my friend Marlene, grandmother of a neighbor who was super-excited about the fundraising campaign for a local spice, herb and tea shop. She seemed skeptical. The campaign, meant to raise money for a new cooler to store and sell local, organic produce wasn't a bad idea — in our neighborhood, it would be the only produce supplier within about a mile focusing on local, seasonal grocery items. And I, for one, could really use a nearby source for lunchbox fruit and last-minute green peppers for my tacos and emergency chili-onions and such.

It wasn't the first time I'd been asked to give money to a friend's business, or the business of a friend of a friend. And I'm not the sort with deep pockets who would traditionally have been asked for small business capital. This is a new approach to business funding; it is either a revolution or a flash in the pan, but it's likely you will be asked soon, too.

Define community-sourced financing in 100 words or fewer?

When I talked about my Kickstarter campaign in August, I was using a broad term, “crowd-sourced funding,” to describe a pretty narrow part of the funding universe. Most Kickstarter campaigns are for creative projects, but more and more are for the sort of small-business capital funding as my friend's produce cooler. And I think a more descriptive term is really  “community-sourced” funding or financing.

Community-sourced financing is a way of going directly to the end-users — the customers, vendors and neighbors benefiting from a business — to provide funding for a project. It works in much the same way as a bank loan, but without the middle man of the bank, and with benefits that are goods and services rather than interest and principal payments.

Examples, please!

Let's take the example of another friend, Rebecca, who is about to launch her Kickstarter campaign to raise money to fund an expansion of her buying club and coffee shop. Instead of just providing wholesale produce, bulk goods, meats, dairy, and other locally produced products through pre-orders once a week, she wants to carry inventory and sell every day of the week. She needs money for fixtures and inventory, as well as working capital to pay extra staff and her vendors. She's trying to raise a lot — $40,000.

Financing the project through a bank is probably a no-go. My friend has been financing this project mostly through her credit cards, and her debt-to-income ratio is exceedingly high. This venture sounds risky — most banks would laugh at the idea of funding her. But her customers and the business' neighbors are another story. How much better would $50 from my savings account be in Rebecca's hands than the bank's! I won't get repaid with interest; instead, I'll get some “perk” or “reward,” like a tote bag or a box of vegetables, plus an emotional investment in the success of this business.

If Rebecca raises the funds she needs, next time I need eggs or lentils or brown rice, I'll be much more likely to go to her; I want to make sure that investment was worthwhile. I know I'm not getting an actual equity share in the business, and she won't give me my $50 back after she turns a profit on the market. But, by selling me once on the idea, she's getting me as a deep and long-lasting emotional stakeholder. I'll share her project because, once convinced, I'll want others to buy into my worldview and validate my investment choices. I'll love the project once it's done, because I've put my money where my mouth was — literally — and convinced others to do so.

Is this a smart investment?

Let's go back to Marlene's question, which I think wasn't so much about whether the fundraising campaign was smart for our neighborhood spice/herb/tea shop, but whether an investment in it was a risky one. And to that I would say, yes. Investing in small business is terrifically risky. Very few small businesses succeed, long-term; many small-business owners aren't terribly smart about finances; most capital projects (and here, I'm only basing this on decades of close observation of businesses whose owners I know, as I don't know of any research on the topic) are not only poor investments, but the exactly wrong use of capital in order to meet the needs of the associated customer base. Very few business owners do what's called a “user needs analysis,” a kind of open-ended assessment of what their customers want, before choosing an investment to meet those needs. Usually, they're just doing what they think their customers want (often, only what the business owner wants himself).

But the scale of the risk is low. Most of these community-sourced financing campaigns give the contributors a tangible benefit in exchange for the contribution. So, you pay $8, you get a bumper sticker; for $100, you get a bottle of wine. Now your contribution is something like that in a school fundraiser or a charity auction: the value of the item you get is less than the money you spent, but you also come away with good feelings and, hopefully, a stronger organization that will benefit you in some way in the future. It's not going to fund your children's art museum field trip or feed the poor orphans; but it will (if it's in your neighborhood) improve your real estate values by keeping strong local businesses, as well as provide a resource for your future needs.

You know I believe in shopping in neighborhood businesses because it pays you back in many ways, financial and sociological; this takes things a step further. You will not actually get a check back with the $50 you gave to the campaign, plus investment returns, in some number of years. But it could be that the financial and emotional returns are two or three times the money you invest. And I feel that cultivating close relationships with business owners in your neighborhood increases feelings of well-being.

So, should you invest in your neighborhood business's capital projects?

If you have an extremely limited budget and you are very serious about putting every spare dollar to work to fund your retirement or some other goal, no. This is by no means a sure thing; even if the project succeeds and the business sticks around, I can't say that you will ever get a dime of that money back, even in lower health care costs because you are so ridiculously happy all the time. (The relative contributions of these things are just too hard to quantify.)

But, if you can spare the money and you believe that the capital project will benefit your life in any way — even a small way — why the heck not? It's likely to just make you feel good, and to improve your local relationships, and if your friends are like mine, they'll offer you all kinds of small random benefits — a free cup of coffee now and again, an introduction to someone who might be a life-long friend or a future boss, an overripe pineapple they couldn't sell anyway and out of which you can make a delicious dessert. Local businesses could very well employ your kids or your perennially out-of-work brother-in-law someday. Healthy local economies will raise everyone's boat.

I'm going to do it — invest in both the neighborhood spice/herb/tea shop capital project and my friend Rebecca's campaign. I told my friend Marlene pretty much the same thing I'm telling you; that it's not necessarily a good investment but the downside is low. (I also advised her not to spend thousands, because that is harder to justify in good feelings and health of the community.)

Go for it. Only if you want to.

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William @ Drop Dead Money
William @ Drop Dead Money
8 years ago

Good article, but a few comments (you’d be disappointed if there weren’t any, right?) (a) Beware the smooth talker. Many of us are geeks, and we’re suckers for fast talkers. That’s why we hate buying cars with so much passion. Same thing here. No matter how worthy the project, if it’s a fast talker, I personally walk away. If the project is good, it doesn’t need a fast talker. If they have one, my immediate assumption is it’s because the project can’t stand on its own two feet. (b) Beware the guilt. All because of YOU this worthy project will… Read more »

AMW
AMW
8 years ago

I agree that this is not a financial investment but depending on the project this can be an investment in the non-tangibles or social investment. However, even if you are doing it as a social investment or charitable donation, do your homework. I have had two colleagues do the kickstarter thing. One had already failed twice trying to accomplish what they were requesting money for and were basically offering fluff in return for your contribution. One was a proven commodity in the industry and was merely trying to shift the focus on her business but was offering services (time based… Read more »

Rosa
Rosa
8 years ago

Exactly this. Every once in a while our direct local “investments” have paid off big time. Mostly, they have done what they should – allowed a local group or business to expand or survive. Several times the group or business failed anyway – it’s a tough world out there, and the reason it’s hard to get a small business loan is because small businesses are a risky bet.

Do it if you can afford it, and you think it’s worth doing. If not, no guilt.

getagrip
getagrip
8 years ago

A financial investment implies a potential direct return of the capital put in plus some growth of that capital, even at great risk of loss. This isn’t a financial investment, it’s a charitable donation. Like any charitable donation you aren’t really expecting your money back, but you feel (hopefully) that your money is going for a larger good and accept the monetary loss against that. So when your friend asked if it was a good idea to “invest” the answer is “no it isn’t, but it may be a good idea to donate.” This is nothing like a “bank loan”… Read more »

MB @ 12 Year Career
MB @ 12 Year Career
8 years ago

This is another incidence of paying more for something you believe in, like the article on buying organic and raising chickens. It’s so easy for me to get caught up in the black and white numbers side of things, return on investment, etc., that I don’t spend as much time as I would like reflecting on the alignment of my money with my values. Definitely some great material for reflection on a Monday morning!

Elizabeth
Elizabeth
8 years ago

From what I can tell, crowd-funding isn’t big where I live (Ontario) so I really enjoy posts that look at the ins and outs of this fundraising method. I feel I’ll be better able to make an informed decision when I start to see these opportunities crop up. I agree with other commenters that is more of a donation than an “investment” in terms of returns. That’s fine too. I did notice one fundraising website crop up in Canada that takes 5% of donations as it’s cut – and PayPal takes another 3%. Does Kickstarter likewise take a cut? I… Read more »

Kate
Kate
8 years ago
Reply to  Elizabeth

I’m in Ontario (Ottawa) and I’ve seen two major instances of this. The first was from the Bridgehead coffee company. They aren’t particularly small (14 locations) but they were looking to purchase their own roaster- a pretty expensive piece of equipment. They did a crowd-funding campaign like this for a period of time (I want to say about 18 months, but don’t quote me on that). A certain donation got you certain benefits, like coffee beans once the roaster was up and going, gift cards, etc. The other was a much smaller but more sophisticated operation for the Crichton Community… Read more »

Elizabeth
Elizabeth
8 years ago
Reply to  Kate

Thanks for the response 🙂 They both sound like great projects. It’s too bad the community centre didn’t raise the funds — but I guess that speaks to the importance of marketing.

Elizabeth
Elizabeth
8 years ago

Pardon me if this is a repeat comment — the “internal server error” gremlins are at it again 🙂 I just wanted to say I thought this post was really useful for me. Crowd-funding isn’t big where I am (Ontario) so I feel I’m better armed to be objective about these opportunities when they crop up. I do agree with other commenters that it sounds like more of donation opportunity than an investment. That’s okay — that’s how I’ll approach it. A question though: do websites like Kickstarter take a cut of the money donated? I noticed a new fundraising… Read more »

Ivy
Ivy
8 years ago
Reply to  Elizabeth

From their website: “Kickstarter collects a 5% fee from the project’s funding total if and only if a project is successfully funded. Amazon (our payments processor) also charges credit card processing fees that generally work out to 3-5%.”

There was an article about Kickstarter in this week’s Time magazine. I don’t have it in front of me but I think it said Kickstarter has small overhead, something like 14 people.

Elizabeth
Elizabeth
8 years ago
Reply to  Ivy

Oh dear. Looks like no one is responding to the “delete comment” request either! Good thing, I guess! Thanks for the response.

Jonathan
Jonathan
8 years ago

This idea is similar to those micro-finance sites like Prosper, where you invest smalls sums with people who don’t have the credit to get loans from traditional banks.

Personally I haven’t bought into the idea of these micro-finance programs yet; however, a community micro-finance project, like a farming cooperative start up is something I’d be interested in.

MB is right when it comes to organic food (something I truly believe in), local organic farmers’ produce is typically of higher quality and the money stays in the community.

Tom
Tom
8 years ago

I agree with the rest of the crowd. To quote:

“I know I’m not getting an actual equity share in the business, and she won’t give me my $50 back after she turns a profit on the market.”

Thus, it is not an investment. Only in the most tangental ways could you argue that there is some return (Perhaps, you’ll save $50 in your lifetime shopping there instead of traveling further for local produce; maybe your goodwill will pay off some other time with this small business owner). But there is no direct return to your investment.

Rosa
Rosa
8 years ago
Reply to  Tom

sometimes they are legitimate legal equity bonds, like the community center mentioned above.

They’re offered to the community because banks don’t think the group is a good bet, usually; sometimes the community knows better, sometimes people are willing to make a low-return high-risk investment because they’d like to see the thing happen.

Mom of five
Mom of five
8 years ago

As these sorts of requests become more common, it’s getting easier and easier for me to say no. I used to feel laden with guilt but now I’m more inclined to think, “if it’s that important to you or your cause, get a side job to fund it.” I have a sister-in-law who runs a welcome center for refugees and other immigrants – a real honest to goodness charitable outreach program. I feel like businesses looking for the type of money mentioned in this article are competing with charities like my sister in law’s for folks’ charitable dollars and it… Read more »

Christine
Christine
8 years ago
Reply to  Mom of five

I agree. I would rather donate to a charity.

Mike Holman
Mike Holman
8 years ago

Agree with others that this is a donation – nothing to do with investing. I think it’s a similar idea to supporting a local business, even if they charge more than a big box store. In my case, I went out of my way to support a tea/coffee shop which was in my neighbourhood, because I really liked having a place like that two minutes from my house and it was worth it to me to make extra trips there and spend more money to try to make that happen. I would only do this if I was interested in… Read more »

elena
elena
8 years ago

I recently supported the purchase of pizza ovens for a local well established restaurant that was expanding their space and offerings.
I thought it was a great way to support a product and business I appreciate having in our small town. I got my money back in pizza and soup. Goodwill is a bonus.

Waverly
Waverly
8 years ago
Reply to  elena

Did you get free pizza and soup, or did you pay for pizza and soup? If you paid, you didn’t get your money back.

Jonathan
Jonathan
8 years ago
Reply to  Waverly

“No soup for you!” =)

Alexandra
Alexandra
8 years ago

Maybe it’s just me, but I found this article difficult to read – proper sentence structure, etc. was sadly lacking. Anyhow, I find this idea offensive. It seems to me that these are businesses who are looking for free handouts from their customers. If your business ideas are sound then you should fund them properly and let the markets decide if your hunch was correct. You will either be right and will continue to provide a service or product that your customers will pay for, or you will be wrong and will be out the money you risked for the… Read more »

T
T
8 years ago
Reply to  Alexandra

This may not be the traditional way to fund a business’s start-up costs, but does that make it “improper”? If people are willingly funding it, and are excited to support the project, then why is it wrong? Also, the investors really aren’t bearing risk, since in most cases, they’re essentially donating money with no expectation of return. I recently met someone in my area who just expanded his small business to a brick and mortar market/cafe, funded by individuals through Kickstarter. I’m really glad that the market/cafe is in our area, and though I was not a contributor, just knowing… Read more »

ImJuniperNow
ImJuniperNow
8 years ago

I like this article. It’s about people helping people, unlike most posts on GRS.

Ely
Ely
8 years ago

It’s not an investment – you won’t get your money back or earn interest, no matter how well the business does. It’s not a charitable donation – this is a business, not a charity, and it will operate for profit. It is, as has been said above, a contribution toward something of value to you that you hope will improve the world or your community. That would be the only reason to give money; that you want to and value the result. Personally I have contributed to a couple of crowdfunded projects that I thought worthwhile, but mostly I ignore… Read more »

W at Off-Road Finance
W at Off-Road Finance
8 years ago

Touching hippie sentiments about brown rice shopping aside, if you don’t get a debt or equity stake you’re NOT investing. You may be buying something with great risk associated (if you’re promised a good in return). You may be giving a gift. But you’re not investing.

All this confusion about how local investing actually works is not doing the investing public any favors.

Waverly
Waverly
8 years ago

What you are describing is a gift, not an investment. When you invest, you want to get a financial return. Giving money away without expectation of making any monetary profit isn’t an investment.

Amber
Amber
8 years ago

Agree with other commenters that the way you phrased this article as “investment” caused some confusion. If I loan $25 on Kiva, I get my money back – very slowly over time. I don’t get any interest, but that’s OK because it is for a charitable cause. It is still an investment – just one earning 0.000% interest with some risk that I will not get the money back (but I have been loaning through Kiva for over 5 years and that has never happened). There are other microfinance sites too, but calling Kickstarter donations or other local-business-based money campaigns… Read more »

Marsha
Marsha
8 years ago

I would really hesitate doing this if I was the business owner. I’d worry that the “investors” would want more free stuff on a regular basis. The author talked about getting an occasional free cup of coffee or overripe fruit–what if you had a lot of investors wanting something every time they came in? I’d be much more comfortable with receiving money through loans, whether conventional or crowd-sourced.

Marla
Marla
8 years ago

It really bothers me that she calls this “investing”. Ick. Like everyone else said, it – is – not – an – investment! Kind of like how buying clothes isn’t an investment.

jim
jim
8 years ago

The idea of for profit businesses asking for hand outs really turns me off.

Investing in businesses that can’t get financing from banks seems unnecessarily risky. The only way I can see doing this kind of thing is if the business owner really treats the business more like a non profit and they actually put a lot into the community and you know that they aren’t pulling a large salary or profit out for themselves. But its hard to know what a small business owner really does with their finances.

Lorin
Lorin
8 years ago

Actually, there are investments like this that pay real money. For example, our CSA has a “green loan” program for members. In addition to your normal produce service, you can lend them money which they will either pay back in produce or, if you prefer, as cash, with interest. You get a better rate of return if you take the produce but both are, as far as I can tell, better than sticking the money in a bank. I’ve never done it myself.

http://www.farmfreshtoyou.com/index.php?cmd=greenloans

Peggy
Peggy
8 years ago

Personally, I wouldn’t feel comfortable with this kind of business financing. JD has referred to the book The Incredible Secret Money Machine, by Don Lancaster before, which says that capital improvements should be funded out of the cash flow of the business, and should be ones that can pay for themselves within two months. That forces the business owner to do the hard work of making the business profitably stand on its own feet, both before and after the capital improvement. “Free money” tends to circumvent that hard work, and so actually endangers the business.

Nihongo Dame Desu
Nihongo Dame Desu
8 years ago

I think this concept is kind of gross, actually, and I’d think less of a friend who hit me up for this. You want me to donate money for your business, so that you can make a profit off my cash? Seriously? That takes some serious gall, IMO. It’s one thing if they are asking for a loan, even if there is some risk, should the business fail. With that, at least I’d get my $50 back (without interest), if the business is successful. That makes sense and seem worthwhile, in the spirit of community or friendship. But to ask… Read more »

Julie
Julie
8 years ago

Great comment!

Ashley
Ashley
8 years ago

I think one of the most important things to remember when you’re trying to get this type of community funding is to make sure you tell a STORY.

For example, if you’re going to sell local community vegetables. Tell people about the small farms and people they will be supporting – how it can positively affect the communities economy as a whole.

Marketing is really just story telling.

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