Thanks to the internet, people in far-distant corners of the world can connect with others located thousands of miles away. This is also why crowdfunding has become so powerful: It allows founders to raise money for their startups from anyone globally through an online platform. Believe it or not, between July 2014 to May 2023, over 22 million people donated to Kickstarter campaigns. But crowdfunding can be risky as it is unconventional; it takes a well-executed campaign to avoid potential pitfalls and reach funding targets. As a result, let’s talk about crowdfunding insurance, the ultimate safety net for early-stage fundraising.
Potential Crowdfunding Risks
Crowdfunding has proven successful for famous projects like the sustainable clothing brand Allbirds, the smartphone gadget PopSocket and the famous card game Exploding Kittens. But why do only 4 out of 10 Kickstarter campaigns get successfully funded?
Starting a crowdfunding campaign too early or being unprepared is possibly the biggest risk a startup might face. If a founder over-sells and over-promises before they can prove their technology and produce a working prototype, chances are they won’t meet deadlines and they’ll disappoint investors.
While Theranos, the healthtech startup founded in 2003 by Elizabeth Holmes, didn’t resort to crowdfunding, this startup perfectly illustrates why unprepared startups shouldn’t raise money at all. Holmes was a promising inventor and entrepreneur backed by prominent investors, and yet, the company’s unproven tech was a scam that never came to life. This led to multiple lawsuits over a decade, leading the founders to serve time in prison.
Lack of planning translates to the misuse of funds, leaving contributors waiting until the end of time to see any progress. Take the Pebble Watch, for example. It was the most successful Kickstarter campaign that failed, raising a whopping $20 million that never led to anything as the startup rushed their campaign and ended up with poor product quality and bad cash flow management.
Benefits of Crowdfunding Insurance
Although founders strive to avoid becoming the next Theranos or Pebble Watch, no startup is exempt from hitting a rough patch due to unexpected circumstances. This is where crowdfunding insurance comes in.
To date, only 23.6% of crowdfunding campaigns get fully funded. The truth is investors would prefer to put their money where they know it’s safe. A startup becomes more attractive for investors when it has insurance because it shows that founders mean serious business. It means you want to protect their capital and value the trust they’ve placed in your venture.
Government regulations will also require startups to have certain protections, like directors and officers (D&O) insurance, if they’re getting funded by non-accredited investors. For example, as per the US Securities and Exchange Commission (SEC), startups need D&O coverage when crowdfunding through Regulation A, which exonerates them from registering public offerings despite selling securities via reward and equity-based crowdfunding.
The Importance of D&O Insurance
Crowdfunding opens the door for anyone to pitch in with as little as $1 for reward-based campaigns or $100 for equity-based ones. So, technically, backers become investors in the company and can sue its executives. Those going the crowdfunding route need to be aware investors can make these claims for several reasons, including purported wrongful acts, inaccurate statements from fiduciary duties, or corporate asset management.
When such legal cases arise, company assets are considered personal assets for directors and officers, which is why D&O insurance is essential to protect young companies and their staff when crowdfunding. This coverage takes care of legal costs so the hard-earned capital startups have secured doesn’t go down the drain due to lawsuits. What’s more, it also protects board members and additional company leadership if implicated in these claims, plus the director’s personal assets.
But make no mistake: This insurance isn’t just there for the worst-case scenarios. Whether you’re doing equity crowdfunding or other funding rounds, many investor term sheets require D&O to ensure their money and employees are in safe hands. Ultimately, it’s the sign of a reputable startup.
Additional Insurance Policies for Crowdfunding Leaders
While D&O tends to be mandatory during crowdfunding, founders can go the extra mile to protect their companies by adding more policies that suit their industry. Here are a few of them:
- Cyber liability: To date, 694 data breaches have been reported in 2023. In this digital era, data is a prized possession, and breaches can tarnish an entire business and its reputation. Cyber liability insurance helps startups get back on track after a cyberattack and protects them in case of lawsuits relating to such incidents.
- Product liability: This insurance covers companies in lawsuits on bodily injuries or property damage due to their product. Product liability also covers ambitious product ideas in their first stages, where malfunctions and defects can be common.
- General liability: This is the quintessential coverage for every company. Known as “slip-and-fall” insurance, this policy covers companies in case of property damage or injuries in the workplace. General liability is especially relevant when startups begin expanding by hiring staff and opening new office locations.
- Professional liability: Also known as errors and omissions (E&O), this insurance covers companies in case of financial damages due to human error and allegations of inadequate work or poor advice, among others.
Building Risk Management Strategies for Successful Fundraising
Crowdfunding isn’t without risks. Take several online investors, all with different expectations of a product or service that hasn’t launched yet. There’s always a chance for human error, misunderstandings, or accidents. Startups must set a risk management strategy in place to plan out incidents before they happen — being one step ahead makes all the difference.
To successfully execute their strategies, companies need to engage in a comprehensive analysis of potential risks associated with a crowdfunding campaign tailored to their specific product and industry. This process involves studying historical data and conducting brainstorming sessions to identify these risks. Following this initial phase, the companies must prioritize their assessment of which risks are more feasible and urgent, as part of their commitment to effective avoid risk management. This proactive approach enables them to implement preventive measures and mitigation strategies promptly should any of these risks materialize.
A robust risk management strategy includes five crucial elements: identifying, analyzing, evaluating, tracking, and treating. Each of these will ensure a startup works on prevention before having to do any damage control. These steps, accompanied by constant and assertive communication between team members, help ensure the crowdfunding process runs smoothly. This process is an ongoing effort, as it’s paramount to monitor the crowdfunding process and revise risk management strategies to avoid any issues.
Download Startup Success: The 5 Steps to Risk Management Checklist
Insurance helps lessen the effect of such incidents after they happen. Having insurance is an assurance that even if a startup’s best preventive measures fail, they can fall back on policies that protect them.