The explosion of internet usage during the early 1990s saw the start of the ‘crowdfunding’ concept, ie using the immediate access of global communities to finance projects. Crowdfunding is the practice of funding a project or venture by raising many small amounts of money from large numbers of people, typically via the internet.
Crowdfunding is undeniably growing fast, even if the amounts being raised by individual companies at the moment are, in the main, quite small
While there is some debate as to where and who started it, the first high-profile crowdfund came via the British band Marillion, which raised $60,000 in 1997 directly through its website to fund a US tour. In 2000, the first ‘platform’ emerged from ArtistShare® and crowdfunding began to be institutionalised. Various charity-based and micro loan platforms developed after this. But crowdfunding really came of age with the arrival of funding platforms Indiegogo in 2008 and Kickstarter in 2009, although they initially focused on arts-based projects. Both raised finance through private equity backers to expand and Kickstarter was named as one of the Best Inventions of 2010. Slava Rubin, CEO of Indiegogo, describes crowdfunding as “all about allowing anybody to raise money for any idea”.
Crowdfunding platforms were hailed as groundbreaking and a way to revolutionise financing. So what substance is there to support this now?
At any point in time, there are thousands of active crowdfunding campaigns. But the majority of these campaigns have a ‘creative’ context. In fact, a number of platforms restrict the activity that takes place on them to some form of creative or social support. If we exclude these and look to the corporate financing context, what do we see?
The bulk of crowdfunding activity is driven from the US, although as the platforms are web based, financing can be raised in any country from anywhere.
There are three broad types of crowdfunding:
This has the largest reach in the crowdfunding spectrum. Companies offer rewards or ‘perks’ for investors. In the business context, these usually comprise items of merchandise. The market is led by Kickstarter and Indiegogo, which have raised approximately $900m and $100m respectively for clients since 2009. The financing largely revolves around pre-selling an item, with the money raised enabling product manufacture or the project to go ahead. The investor typically has to wait for a period after the ‘campaign’ closes to receive the product or service purchased. Most campaigns raise low thousands of dollars. There are notable exceptions, however, which could indicate the beginnings of a more sophisticated investment approach. In May 2013, US watch company Pebble raised $10.3m through crowdfunding and UK technology company Ubuntu Edge raised $12.8m in August. So far in 2013, Kickstarter has led 49 campaigns and Indiegogo has led seven campaigns, which have raised in excess of $1m each. The number of Kickstarter campaigns is up from 17 in 2012. Meanwhile, the geographic spread of projects is also significant. In 2012, Kickstarter delivered finance for projects in 177 countries. The crowdfunding platforms do undertake some screening of projects, but this sector is unregulated.
This is not available universally due to ‘public offering’ rules, but it is growing fast. In 2011, the Netherlands adopted rules to accommodate investment by unaccredited investors. After much debate, in October, the Securities and Exchange Commission allowed businesses to raise up to $1m in any year (rule 506c) by selling to accredited investors. Already, some states are challenging this approach as being too restrictive.
Crowdcube leads the UK market. Since its inception in February 2011, Crowdcube has helped 81 businesses to raise £16m. Most of the investments were for start-up or early-stage businesses, although 23% were growth businesses. All of its projects benefit from Enterprise Investment Scheme/Seed Enterprise Investment Scheme tax relief and, in the main, are relatively small, with an average investment of £187,000. But it is worth noting that Crowdcube raised 400% more in 2013 than in 2012 and the size of the equity deals is increasing. In September, Crowdcube raised £1.9m for Hab Housing, the company led by Grand Designs television presenter Kevin McCloud.
Also known as peer-to-peer (P2P) funding, it has had a mixed reception. Undoubtedly large amounts of money have been ‘matched’. In the UK, Zopa has lent in excess of £400m. But there are concerns around investors being enticed by high interest rates to lend money to very risky proposals and that there is limited checking of the projects. In October, the UK Financial Conduct Authority announced a consultation to tighten the rules prior to assuming regulatory responsibility in April 2014.
The cost of running a campaign varies on the type of funding, but ranges between 4% and 11% of the total. Typically, there is then a credit card cost (most pledges are made via credit card) of around 3%.
For the investor, there is not usually any cost, unless they are making a cross-border investment, where they might incur fees.
There are a number of advantages to crowdfunding:
“We thought we would launch the project and then people would come. We did not realise you had to work at it. We would not crowdfund again.” Unsuccessful crowd project leader
Crowdfunding has a low success rate, ranging from between 30% and 40%, depending on the type of financing.
Often the people who launch projects seem to have a sense of naivety when it comes to crowdfunding, but given the size and limited resources of most of the companies involved, this is probably not surprising. Conversely, extensive planning, use of social media, and articulating the story and the benefit to investors can drive a successful funding. The principle is no different from any other financing process.
Like all financing transactions, momentum is key, but once you get this via the web, Facebook, Twitter, etc, the transaction can become self-sustaining.
Crowdfunding is undeniably growing fast, even if the amounts being raised by individual companies at the moment are, in the main, quite small.
But approximately $1.5bn was raised through crowdfunding worldwide in 2011, according to crowdfunding research firm Massolution. It is estimated that amount doubled in 2012, and growth is accelerating. Latest projections indicate the amount raised in 2013 will exceed $5.5bn. There are now estimated to be over 500 crowdfunding platforms worldwide.
New entrants are being attracted to the equity/debt side of the market:
The flexibility of the crowdfunding concept will bring larger companies into the frame at some point, particularly when they work out how to really leverage their own online communities.
It would appear that crowdfunding is here for the long term. It already has a place in SME corporate financing, but it is largely fulfilling venture capital-type funding. There will inevitably be some issues with regulation as the markets grow, however, which has already been seen in the UK and US.
The reality is that crowdfunding is not going to replace traditional private equity or investment banking activity any time soon, and it remains largely a microfinance tool. But it already looks as though the transition is beginning, complementing the financing toolkit with real potential for the future.
Melvin Pointer FCT is a co-founder of customised sunglasses maker Melon Optics and honorary treasurer of the Queen’s Nursing Institute