Financing through Crowdfunding Platforms
In this article, we will look at 1) what is crowdfunding?, 2) types of crowdfunding, 3) different crowdfunding services, 4) pros and cons of crowdfunding, 5) crowdfunding and venture financing, 6) leveraging crowdfunding successfully, and 7) crowdfunding success stories.
WHAT IS CROWDFUNDING?
Crowdfunding is the use of a network of friends, family, colleagues or strangers to collect small amounts of capital to finance a new business venture or further an existing one. Crowdfunding activities usually take place over the internet with social media often playing a key role in getting the word out regarding the venture to be funded. This method helps expand the number of potential investors from the traditional group of business owners, their relatives and venture capitalists.
Typically, there are three main players within a crowdfunding model. These are the project initiator, the project supporters and a moderating platform. The initiator proposes an idea which needs funding, the supporters may be groups or individual who are interested in supporting this idea and the platform may be a company or a website that connects these two parties with each other.
Within the United States, there are SEC regulations and restrictions that govern crowdfunding. These may restrict who can fund a new business and how much they can contribute. They may also subject the project initiator to several regulations especially if they aim to offer a stake in the business to an investor or investors. Though many feel that these restrictions often prevent businesses from getting off the ground, they are in place to attempt to protect unsophisticated or less wealthy investors from putting their savings into a risky venture. Since many new businesses tend to fail in the early stages, these investors also face the risk of losing their initial investment.
History of Crowdfunding
In 2003, crowdfunding began to gain footing inside the United States with the launch of the first crowdfunding website called ArtistShare. The earliest recorded use of the term itself was by Michael Sullivan in fundaylog in 2006 as reported by WordSpy.com
After ArtistShare, many new sites began to appear online. These notably included ChipIn and EquityNet in 2005, Pledgie and Sellaband in 2006, IndieGoGo and GiveForward in 2008, FundRazr, Kickstarter and Fundly in 2009, GoFundMe and Microventures in 2010 and Fundageek in 2011
In 2010, these websites resulted in a contribution of US $89 million. This money came from the public and went to a variety of companies and individuals selling unique ideas. This figure rose to US$1.47 billion in 2011. In 2012, the figure was US$2.66 billion with one million individual campaigns established worldwide. A 2014 report by a UK based organization, The Crowdfunding Center, released data that showed more than US$60,000 raised and 442 campaigns launched every hour every day.
TYPES OF CROWDFUNDING
There are four main types of crowdfunding. These are:
- Donation Based Crowdfunding: In such type of crowdfunding, the investor simply gives money to support a cause with no return expected. An example is funding a sports team to attend a tournament.
- Reward Based Crowdfunding: In this type of crowdfunding, people invest in a business in exchange for a reward of some sort. This is usually a product or service the business is aiming to offer after receiving funding. Essentially, the business presells its concept. This model has been used extensively in a variety of areas such as free software development, movie promotions, inventions, scientific research, and civic projects.
- Equity Based Crowdfunding: In this type of crowdfunding, a stake in the company is given to a group of people who finance the business. As part-owners of the company, the investors stand to make a return on their investment with a share of the profits. This is in the event that the company manages to survive and become successful. SEC restrictions apply to this type of funding in the US.
- Debt Based Crowdfunding: In this type of crowdfunding, the company asking for investment does not sell a stake in the company but borrows money from potential investors. The transaction is a legally binding commitment to return the loaned amount at regular intervals and some predetermined interest rate.
DIFFERENT CROWDFUNDING SERVICES
There are several crowdfunding platforms on the internet with new ones appearing every day. Here, we list the top sites chosen by Sally Outlaw. Outlaw is the founder and CEO of peerbackers, a crowdfunding website. She chooses sites that have the best track records and have been functional long enough to build traction and reputation. A more comprehensive list can be found here.
She divides her selections with three crowdfunding types: reward, equity, and debt.
The top crowdfunding websites in this category are:
- IndieGoGo: This website began with a focus on film but quickly expanded to include everything. It is better known for financing personal and cause related projects and campaigns. All projects are accepted without the need for a review. If a campaign raises money successfully, the website charges a 4% fee while an unsuccessful campaign needs to pay as much as a 9% fee.
- RocketHub: This website focused initially on the arts but expanded to accommodate science, education, business and social projects. There is an annual SciFund Challenge to fund science projects.
- Peerbackers: This website keeps a focus on entrepreneurs and innovators. Projects listed are usually of the creative, civic or entrepreneurial nature. There is also a category for young entrepreneurs who range between ages 13 and 17. This is in partnerships with student organizations. There is also a Crowdfunding Academy to educate and support those who want to venture into crowdfunding.
- Kickstarter: This is the most recognizable crowdfunding websites. The focus is on creative ventures such as design, film, publishing, music, gaming and technology. Though the website does not directly allow funding for businesses, it accepts products and has resulted in some successful campaigns. Not all projects are accepted, and the website has a rigorous submission process. The service is open only to people from the US, the UK, and Canada.
Websites in this category are slightly different in that they usually fund through accredited investors and not general crowds. Investors may back low-investment projects, however, using the pooling element of more traditional crowdfunding.
- Grow Venture Community: This global platform for entrepreneurs and investors is community-based. This website is more of an ecosystem to support entrepreneurs in connecting with experts, funders, team members and new customers to make ideas successful.
- MicroVentures: A sort of investment bank for startups, the website will conduct due diligence on these startup ventures, and if they meet the mark, help raise capital from angel investors. The platform is SEC approved, and investors can invest smaller amounts.
- Angel List: This platform is more limited in its reach with entrepreneurs having had raised $100,000 and incorporated in Delaware, US. The website has a good system for reaching a strong pool of investors.
A few crowdfunding websites in this category include:
- SoMoLend: This is a peer-to-peer platform and helps facilitate friends and family loans, as well as loans from accredited investors and banks. The website is designed mainly for established physical businesses with customers and cash flows that can service debt. Instead of FICA scores, the website will consider other factors such as social reputation, behavior and online presence among more traditional factors. These factors help determine the interest rate.
- Endurance Lending Networks: This website connects small business with nontraditional lending sources such as accredited individuals, family run offices, wealth management concerns and debt funds. The cap on the debt amount is $500,000. A sophisticated credit algorithm is used to aggregate and filter opportunities.
PROS AND CONS OF CROWDFUNDING
The crowdfunding environment brings with it a few new principles. These principles have their pros and their cons.
Less time is spent on generating capital, and less capital is generated by an entrepreneur himself
The upside of this situation is that an entrepreneur has to spend less time running after capital necessary to run their business and can spend more time developing the business and the related product or service. People with no income and a humble financial background are no longer held back by the lack of funds.
The downside is that when there is less investment from the entrepreneur themselves and they are not answerable to an investor one on one, the necessary step of continuously convincing others of the value of the business is lost. There is less feedback and questions and less opportunity to fine tune early business models.
There are more investors with smaller stakes at early stage financing
The upside of this situation is that it allows more people to be involved in new businesses, and it no longer remains a case of the rich getting richer. There is a more diverse base of investors and less obligation to a single group of investors.
The downside of this is there is almost no due diligence by the investors, and they are more susceptible to fraud, incompetence or an ill-thought out plan. Investors may not be close enough to find the right data to allow them to make smart decisions, and many won’t be able to understand the potential risks of investing in a crowdfunded campaign.
More ideas get funded
The upside here is that ideas that are more complex and niche can get funded whereas a traditional investor may find them too risky or may not see the potential value. People pitching these ideas have more leeway to develop ideas reliant of high creativity that push boundaries.
The downside is that crazy, impossible ideas may also get funded. Many crowd funded ideas will never be successful and result in lost investment. The smaller investment amounts ensure that the loss to any one investor is not too substantial, but a sustained number of these losses may give crowdfunding as a whole a bad reputation and subject it to tighter regulations.
CROWDFUNDING AND VENTURE FINANCING
Through crowdfunding, a much larger number of people are able to fund their dream projects and businesses. This freedom to raise capital may mean a shift in how traditional venture capitalists operate. These venture capitalists make money from their investments into promising startups and will now have to work harder to attract the right entrepreneurs.
Both modes of raising capital target different markets. A venture capital investor will not want to fund an art film or a new music album. On the other hand, crowdfunding will not be able to raise a substantial amount such as a record $1.2 billion raised by ride hailing app called Uber in a round of VC funding.
In the areas that do overlap, crowdfunding is something for investors to watch out for. A successful crowdfunding round will give a startup more leverage to come up with better terms and conditions in subsequent, more traditional investment deals.
LEVERAGING CROWDFUNDING SUCCESSFULLY
As crowdfunding becomes more popular and there is a growth of the number of platforms facilitating transactions, it is extremely important for a potential campaign to have the right ingredients needed to attract the maximum number of investors. Some important facets to consider before designing such a campaign include:
- Strategic Use of Social Media: Though covering all aspects of social media may not be necessary, it is a good idea to have as a wide a reach as possible. This means picking the right networks to compliment marketing and content strategy. This will ensure that the right supporters are targeted. It is important to tweak the message to suit a particular social media platform.
- Use Video Clips: Properly made video clips can help potential donors get a better idea of what is being pitched. A product or service can be seen in action rather than through a series or stills or a wordy brief. But this step should only be undertaken if time and effort can be dedicated to making the video look professional and not an amateur job. If finances allow, a professional can be hired to do this.
- Create a Media Page with Relevant Information: To get the press interested in covering, it is important to have a nicely designed webpage with the right press informational material. Journalists can then download what they need to create a story. For larger plans, a press release and even a press tour may be needed.
- Wait for the Right Time to Ask for Money: With the right enthusiasm and the story of the project presented, people will want to add support naturally. Make sure the backers know what they are supporting and what they can expect in return. Backers should be allowed to invest as little or as much as they want.
- Build Interest: Before and during the campaign, it is necessary to generate interest in the business. A pre-existing fan base can help a campaign achieve a strong start. A blog, a documentary, or a social media presence can help generate this interest.
- Keep Communicating: If there is a positive development of a setback, it is necessary to keep investors in the loop and to give them regular updates. Even after the campaign has ended, it is good to keep the process going.
- Add a Personal Touch: Introducing the team and yourself are a good way to make people feel connected to real people rather than a business front. The more personality that shows through in a campaign, the more likely people are to be interested enough to take action.
- Appeal to an Existing Fanbase if it Exists: Popular American sitcom Veronica Mars managed to gather enough support for a feature length film after lack of success in the same regard with major film studios. The campaign was geared towards existing fans of the show, and there was very little effort to gather new interest. In a similar situation, special attention should be paid to existing fans and supporters.
- Create Mass Appeal: Despite the importance of generating a fan base and appealing to an existing one, it is also necessary to create a campaign that may appeal to whoever visits the page.
CROWDFUNDING SUCCESS STORIES
There are many examples of successful crowdfunded projects and companies in all categories. A few of the most successful campaigns in business are given below:
- The Pebble E-Paper Watch: This campaign is known for being Kickstarter’s breakout success, raising $10,266,845 in just 37 days. Investors were excited to be among the first to own a pebble watch, the first affordable smart watch on the market. However, months passed, and the company was unable to deliver orders. The company managed to deliver the first round of watches within ten months of the campaign ending. The event led to the announcement that Kickstarter was not a store.
- Ouya: This is an open-source gaming console. It took the gaming world by a storm and managed to raise $8.5 million in 29 days through Kickstarter. Within 10 months, the consoles were delivered to the crowdfunding backers.
- Pono Music: A recent Kickstarter Success, the service claims to provide a unique music listening experience by allowing a listener to hear the music as the artist intended. It managed to raise over $6 million in one month. The music player was expected to be delivered by October 2014.
- Bitvore: This service allows businesses to monitor and analyze large continuous streams of data. An equity campaign was launched on Fundable, and $4,500,000 were raised to develop the product further.
- The Dash: This is the world’s first wireless smart in-ear headphone. It is in part a music player and in part a fitness tracker. It managed to raise $3,390,551 in 50 days. It is supposed to be delivered to backers by October or November in 2014.