Will crowdfunding help create more ambitious companies?

Entrepreneurial networks have been buzzing about crowdfunding. In many instances, this has been going on for some time, certainly since the growth of this alternative approach to business funding first became noticeable in the latter years of the last decade. However, there is a sense that crowdfunding might now be approaching a game-changing point, where a relativley new industry that has attracted its fair share of suspicion could be on the cusp of something approaching respectability. All of which might prove rather timely given the needs for new business funding in parts of the world that are otherwise too indebted to provide it.

The game-changing element isn’t one big deal – there are now myriad examples of businesses who’ve used crowdfunding to become airborne. One of the latest is the Rushmore Group, owner of three members’ clubs in London, which has recently secured £1 million investment from 143 investors to fund the development of an exciting new venue in the heart of the city in 2012. The investment, raised in only four weeks through the equity crowdfunding website Crowdcube, allegedly sets a new record for the largest amount of money raised in the shortest amount of time from a crowdfunding website. Perhaps of more significance is the fact that Crowdcube uses inexpensive but well regarded FSA-authorised analysts to review each proposal and help them prepare compliant documentation. This means that  each proposal is a ‘financial promotion approved by a person authorised by the Financial Services Authority‘, which lends a cloak of respectability to its financial structure.

WHAT IS CROWDFUNDING?

If crowdfunding is to make a step change, some of the mystique in the term probably needs to take a bath. A concept that is relatively straightforward has been entangled in myth as it has evolved. Ari Massoudi writing for Wisepreneur disentangles the thread rather well in his description: In theory, it is very simple. You have a project to finance, you present your project in a web site, and you promote your project to people and ask them to give you money! If people like your project, they will talk about it to their network, and then a viral funding process could start.

The kinds of funds that could be raised by crowd funding are:

  1. Donations
    Preferentially non-profit projects. But some companies on the Internet offer a free service based on open-source software (freeware or shareware) and can have significant revenues from donations by their customers (users).
  2. Loans (long term debt) or Credit (short term debt) 
    This kind of crowd funding is named Peer-to-Peer lending. Dr. Calvin Bacon has published two instructive articles about Peer-to-Peer lending, New Ventures: Is Peer to Peer Lending a Good Funding Solution? and Which P2P Lender Should You Choose?.
  3. Royalties 
    The investor bets his money on your project, and in the case of success, the entrepreneur pays-back royalties to the investor (a percentage of the sale revenues).
  4. Stock Sales 
    This concerns private companies, such as start-ups, small and medium-sized enterprises, seeking equity investors to finance their development. The goal of the investor is to obtain a capital gain after the sale of his stock, and to receive dividends when the start-up has profits.

Donations, Loans, and Royalties can be used for entrepreneurs at a very early stage of their project, before having a tangible product (good or service) to sale, even before the legal creation of the company. Stock Sales is a novelty. Indeed, we can easily buy (or sell) stocks of public companies on the Internet, but now, we can do it with private companies also.

In addition to Crowdcube there are now a great number of crowdfunding sites. Here is one of the most exhaustive lists we’ve come across, but a more distilled collection of ones to watch would likely include the following 10:

IS CROWD FUNDING THE ANSWER?

It’s hard to argue against anything that illuminates the nuts and bolts of business funding, especially in times like these. In this respect crowdfunding has to be a welcome addition to all the means of stimulating innovation and growth that already exist. And if the traditional financial services establishment, from banks to venture capitalists, is not prepared to help new businesses find funding, then why not let the people help themselves. It has a certain revolutionary romance.

Most companies self-finance. Source: Bibby 2020 Vision

However, one of the most telling observations about SMEs is that most of them aren’t remotely interested in raising funds. This is not because people won’t lend them money or invest in their business, it is simply because they don’t choose to ask. They prefer to finance their business growth via other means than saddling it with debt or ceding control of the equity. This means that companies aiming to raise funds are a tiny minority and those aiming to raise serious investment even more so. Crowdfunding is therefore a small drop in the ocean and unlikely to seriously challenge more orthodox routes to venture capital. Yet potentially that is missing the point. Whilst it is conceivable that over the course of the next five years we will see the odd example of something akin to one of the privatisation programmes of the late 1980s, with considerable public ‘share’ ownership in a business or business idea, it’s unlikely to become a mainstream trend. Yet that doesn’t mean it should be discouraged – far from it. It is the ethos of crowdfunding that has perhaps been its most compelling characteristic, supporting the idea that business funding should be democratised and demystified and housed in a process that is abundantly transparent. And the influence of this ethos has more widespread commercial benefits that are worth cultivating. Here are three that are worth emphasising:

1. Improved Business Planning. Speaking recently at Silicon Valley comes to Oxford, Reid Hoffman, the Linked In founder and serial new business investor, said many ventures seeking funds still don’t properly think through where they fit in to the markets they aim to penetrate. Incorrect sizing of the commercial opportunity and the company’s competitive circumstances are still widespread barriers that fund raising amplifies. But in asking the right questions any funding process arguably forces entrepreneurs to think further ahead and arrive at more water-tight justifications for the paths they are planning to take. If more people thought about raising money more people would be thinking more seriously about the plans that underpin this activity – and that has to be a good thing.

2. Network Utilisation. Whether they are conscious of it or not, all companies belong to ecospheres containing other businesses, so the idea of a standalone company is not squared by reality. And the evidence suggests that the more networked a company is the more chances it has of becoming successful. As a network model crowdfunding can be a highly positive influence on the development of any company’s sphere of influence. In addition to identifying investors the by-products of crowdfunding can include the identification of potential partners and collaborators, all of which are important cogs to business growth.

3. Changing Business Culture. One of the most profound ironies of the current economic climate is that many economies actually need more businesses to borrow or raise money. As a key indicator of business ambition the decision to seek finance is pretty unmatched and the world needs more of the ambitious, fast-growth companies that create the lion’s share of new jobs. One of the obstacles standing in the way of this is the aversion to thinking about funding as an obvious departure point. If the appeal of crowdfunding can help shift this dial just a fraction then maybe the growth for which everybody is anxious will start to improve the conditions that helped nurture crowdfunding in the first place.

Index B studies the behaviour of thousands of companies and the key trends that drive them, to provide insights and intelligence about the way businesses behave. To find out how Index B can future-proof your company please visit our website.

Comments

  1. I hope other people think your write-up right here as helpful as I have. I manage a blog site myself and would be very happy for you or the guests on your own web site to check out. Please go ahead and look through my website just like I have with your own and leave a remark or two if you discover anything interesting. Thanks again.

  2. Cary Harwin says:

    Good article. As the co-founder of a new site, FundaGeek – Crowdfunding for Technical Innovation, let me share some additional perspectives as to the valuable use of Crowd Funding for a business.

    First, let’s take the scenario where you are trying to raise substantial dollars for equity from either an Angel or VC. I firmly believe, from decades of entrepreneurial experiences and consulting services, that the BEST way to ‘attract the attention’, and engage any investor, Angel or VC, is to be in the position of coupling your presentation with a “proof of concept” and validated marketing acceptance, consumer demand, and holding rights, at least in the form of a ‘provisional patent’ of which its value has increased since the passage of the recent Patent reform law.

    If you need the funds to take you through the obtaining of “proof of concept” and obtain your ‘provisional patent’, crowd funding is a great avenue.

    If you want to start a new company and you are ‘boot strapping’ initially rather than seeking loans or investment for equity, and your new company is providing a unique service or new product, then promoting it to your contacts and people who have an interest in the area that your product/service addresses, then ‘pre-selling’ your product or service in the form of rewards for pledges can be a wonderful way to acquire your seed money.

    The reality is that Crowd Funding puts the power in the individual’s on hands, the possibilities are limitless. Check us out, http://go.fundageek.com/li

    • Index B says:

      Thanks for the comments – you’re absolutely right – we’re still scratching the surface of the potential of Crowd Funding – you’re also right to break the value chain into different components. It will be interesting to see if Crowd Funding helps nudge boot strappers up the funding ladder and help create the kind of cultural change to investment that we think will need to happen during the next decade.

  3. john says:

    Hi Index B,

    Great post, it gives me good info. Thanks for sharing.

  4. Wow this is a must view, bookmarking your site now. Please continue to write, your style is very unique.

  5. Hey good blog!!

  6. Odell Ravi says:

    thanks great sharing, this is very helpfull

  7. very nice post, i certainly love this website, keep on it

  8. First let me thank you to have cited my article, it’s great! And thanks for your very interesting analysis about crowd funding for seed stage new ventures (from idea to prototype/prove of the concept).
    As complement, I invite you to read this hereafter article focusing on the type 4 (also called Micro-investing). In this article I show how early-stage startups (incorporated companies, having a product, a beginning of sales) can use crowd funding to raise funds in exchange of their equity (like business angels or VC investment, but here each share can be bought directly by people through the website with a credit card!) :

    http://wisepreneur.com/funding-innovation/how-to-invest-using-a-crowd-funding-website

    Cheers,
    Ari

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  2. [...] Will crowdfunding help create more ambitious companies? – Future … In many instances, this has been going on for some time, certainly since the growth of this alternative approach to business funding first became noticeable in the latter years of the last decade. However … Source: futureofbusinessblog.com [...]

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