“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.
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.
Author: Sarah Gilbert
Sarah is a blogger by trade and a finance geek at heart. She cut her teeth on her first Excel spreadsheet full of financials at the tender age of 21, when she began her investment banking career in First Unionâ€™s Loan Syndications group. She went on to get her MBA from Wharton, work at Merrill Lynch and fall in love with analyzing company strategy and endless rows of numbers. She got into blogging as a marketing strategy and the blogging took. She now is a freelance financial and (award-winning!) literary writer, working in between baking bread and finding socks for her three little boys in her beloved 1912 Portland, Oregon, home.
Sarah's even-more-personal blogging about being an Army wife, parenting, food, biking and life can be found at urbanMamas and Cafe Mama.