Since the US Senate passed the Crowdfunding Bill to allow Crowdfunding investments, the hype surrounding this market sector is gathering momentum! The Bill is legalizing the Crowdfunding business model as the CROWDFUND Act is an amendment to the JOBS Act!
2008 was a particularly trying time for the economy with the Banking sector being one of the hardest hit. This obviously had a knock on effect on businesses due to banks shutting the doors on financing entrepreneurs and small businesses. This further more put more pressure on the private sector with many new start-up’s business’s failing before their ideas even got off the ground!
With THE CROWDFUNDING Act in the US and the emphasis Vince Cable, the Secretary of State for business, in the UK is putting on for opportunities in Crowdfunding means it is a positive sign for this sector. Also the steady amount of media attention for sites like Kickstarter in the US hitting headlines with business ideas that have been received with ground breaking investment backing mean this sector is only heading one way in the immediate future and that is up!
What is Crowdfunding and How does it Work?
Crowdfunding is essentially a Private Equity business model that relies on the public to raise capital to fund start-up businesses or businesses that need funding for further growth. It’s an alternative method of raising finance (investment) for a business project or idea.
The Private Equity model does however expand slightly on this model but this is all documented in our ‘What is Private Equity?’ articles on our Private Equity Pages.
It is also slightly different to the angel investment approach where one person usually takes a bigger percentage of the business for his investment. However with Crowdfunding an entrepreneur can attract a number of people (a crowd) of which they all take a small stakes in the business model for the exchange of investment (finance).
There is huge benefits to funding a business model in the Crowdfunding way as you can convince 1000’s, and in some cases millions, of investors instead of targeting just one investor who may not like the unproven business model you’re trying to pitch!
How much will it cost to invest?
This is a toughie for Philip and I and something that will need to be addressed in the future for Crowdfunding to become something that is commercially viable and economically viable for the investor. Here is our quandary:
As a Crowdfunder most projects will allow any amount of investment from $1 to fully funding a pitch. For this example we will use a minimum Crowdfunding investment model of $100
- Paypal fee’s = 4.1% = $4.10
- CrowdFunding Platform = 5% = $5.00
- Equity left for Start-up = $90.90
The business start-ups are losing 9.10% of capital before they even give a % of their business away in the way of an incentive to invest.
I must stress that as the investor in the Crowdfunding project, you will not have to bare these costs as they are taken at source once you have made your investment, so you will in fact see a balance of 100$ if you make a 100$ deposit. Some Crowdfunding platforms do take the PayPal charge so read the small print to make sure! Also the platforms 5% charge will only come into effect when a project has a successful funding round so it will only be the company that is financially (9.10%) worse off! So whether you’re a funder or a business looking for funding, look at the costs associated with any project you might pitch or fund!
Could Crowdfunding Benefit my Business?
Now we have got some of the negatives out the way with how much it will cost you let’s look at how beneficial this could be for your business! If you watch the TV programme Dragons Den you will understand that most investors come to the Den not only looking for investment to get an idea off the ground but at the same time, gaining the knowledge and support from a specific Dragon.
For any investment project we deem viable, we always like to see if there is an area to the business that crosses over with another asset we have in other sectors or the same sectors. This is so we can consider taking both projects to gain a synergy effect therefore building a stronger business together and using experts from each of the business to reduce costs on the overall research and development! Also if there are certain parts of the business that can be used to get products into other customers and broadening the range of products being sold into one company and growing market share. Contacts are so important when selling products so using existing contacts as a strength for future growth.
That is just a quick example of why a Dragon can be more important than just the money in his pocket.
How Crowdfunding can benefit start-up businesses
- With Crowdfunding you can create a network of people that support your idea. These networks are likely to endorse your products and recommend you at every chance they get as if you fail, they fail! The crowd who funds you will probably become a customer of the product they have backed therefore meaning they will be a repeat customer.
- Another benefit is that in some cases that professionals offer their services for less or the best case scenario, for free! So if you’re an accountant and feel you want to help with the books or a solicitor with recommendations of legal advice this can come in handy to the start-up as if there is anything they need help with they can call upon the crowd!
- Because the Crowdfunding Platform is promoting ideas to its web visitors daily, this can attract media attention and huge brand awareness for your start-up which you wouldn’t necessarily get if you were trying to do it with a bank loan. This can generate new customers, potential suppliers and just from a single press release give it a sense of trustworthiness making it easier to gain the faith of future investors.
- There is nothing faster than walking into a bank asking for a loan, having it approved and then receiving the funds a week later directly deposited into your bank! However, as a form of funding, the CrowdFunding process is also relatively quick with most platforms using a 90 day pitch so if it is not fully funded in 90 days the pitch is removed from the website. Three months sounds a long time but some projects do get funded a lot quicker than the allocated three month period set for expiry. But in Private Equity / Venture Capital sector this can take months if not more than 12 months sometimes to finalise on a deal and secure investment for a particular project depending on the complexity and due diligence need to be carried out. So you could say that Crowdfunding is a fast way to secure finance for a start-up.
- Crowdfunding has created a simplicity for getting your friends and family to invest in a project. Also social media has made it easier than ever to share what you’re doing and investing in, allowing a project to go viral amongst friends and family or even better worldwide!
- Something always on the mind of any investor is what benefit this will have on their taxes. In the UK from the 6th April Investors that pledge between £500 to £100,000 in an approved Enterprise Investment Scheme benefit from a 50% tax relief!
How will I know if Crowdfunding is right for my idea?
Crowdfunding is most effective for business ideas that have a common appeal with a crowd that is interested in investing. If you can tell a story and you’re passionate about the concept this can be reflected through the pitch helping others follow your ambition to make the idea happen. An example of this is that many successful Crowdfunding models have been targeted towards the socially sustainable sector which gets people involved in something they can already be passionate about therefore getting them excited and inspired to make an investment in a Crowdfunding idea!
Philip and I, in our Stock Market Education site, refer to the phrase KISS (keep it simple stupid) and it doesn’t matter if you’re trading the markets or investing in seedling companies the same thing applies. For businesses that are pitching ideas and projects, this really is a deal maker or breaker! If you make things complicated you could find that you alienate potential investors subsequently killing your pitch so always break it down to the core model and make it easy to understand but still exciting!!
How do I Protect my Idea?
Copywrite is a potential issue with releasing a pitch on a Crowdfunding website, as you’re releasing your concept/idea/project into the public domain. It’s not like you can get 1000’s of NDA (None Discloser Agreements) signed before the idea can be reviewed and this is an area of the Crowdfunding business model that should be addressed.
With this, you just have to see the positive side of it and be confident that you were first to market with this particular Crowdfunding project so if the project is successful you’re more than likely to be ahead of the competition giving you a head start with market share. Plus you have the added value of a Crowdfunding network as described above.
Reaching Your Crowdfunding Target
What happens now? When a target is reached on a Crowdfunding platform there is a short cooling off period as with any business transaction. As frustrating as this may be to the project owner, some platforms also ask the investor to confirm their investment allowing them to withdraw their investment at this point if they wish (don’t pledge if you cannot invest!) The Crowdfunding website then goes through all of the legalities and refer it to Solicitors/Lawyers to formalise the deal and then transfer the money to your bank account.
As the project manager / owner of the business you will be given details of investors in your project so you can liaise with them to begin processing their incentives / interest / products. If it is an equity based deal then the lawyers will have drawn up the relevant paperwork(share certificates) detailing their share holdings in the company.
What is required from a successful pitch
If your Crowdfunding pitch is successful we believe you have a commitment to inform your investors of progress in your business. This depends on what type of equity reward based offer was given but still you have their information so use it to build good investor relations as you will never know when you might need to call on the crowd again. Your commitment officially ends if it is reward based when you have fulfilled your delivery but why stop there!
- Create a mailing lists
- Investor Discounts / promotions
- Prove how you’re hitting your financial targets and growth expectations.
You should never be concerned with investors becoming too involved or having a say in the day to day running of your business. You will have only released a proportion of equity which would result in them only holding a small % shareholding in your business.
Where Crowdfunding can go from here
One thing a Crowdfunding Platform does not do is a full scale Due Diligence report on any pitch that is subjected to the Crowd. We believe that there could be some possible litigation cases that may spring up because of immoral businesses as people may see this as a way to funding something that really only benefits the creator in the long run!
Crowdsourcing.org has nominated itself as the Crowdfunding association organisation that will moderate and give accreditations as an intermediary regulator for Crowdfunding. It will be interesting to see the lengths they go to protect the investors from fraudulent business opportunities.
The Crowdfunding Accreditation for Platform Standards (CAPS) program is an initiative by Crowdsourcing.org to promote the adoption of best practices for the operation of Crowdfunding platforms globally.
Our advice to any Crowdfunding investor would be to stay sharp and be as diligent as possible when funding any projects that are pitched to you on these sorts of sites. Be aware that you probably will not be able to do a lot of research on the project, creator or team when investing in this way. If you have this to the back of your mind and only allocate money that you’re happy with possibly losing you will have a bit of fun. Who knows, you may be lucky enough to pick the next Facebook or Google!