Crowd funding supporting projects or businesses is catching on in a big way. Not only does the model provide finance but it provides access to a larger number of people (crowd) who can test and externally validate an idea. Crowd funding takes a number of different forms including donation, reward, lending and equity. It is a way of financing projects, businesses and loans through small contributions from a large number of sources, rather than large amounts from a few.
In this blog I’m going to focus more on the rapidly growing equity type crowd funding, where individuals receive small stakes in a privately owned young business in return for investment as this is the area of crowd funding that has caused the most controversy of all!
What is equity crowd funding? In equity crowd funding businesses sell shares in their business to the crowd in return for cash. The investors become shareholders in the company with all the legal rights that this entails, for example, the right to dividends and the right to sell their shares in the future. One of the main reasons this has caused the most controversy is the principles of protecting the small investor from making risky investments where they can lose their money. However, this is the specific purpose of equity crowd funding as it allows and enables investors, who could be friends, family and strangers, to make as many small investments into companies as they wish!
Why would a business choose to crowd fund to other traditional forms of finance? Grants – Entrepreneurs often struggle with accessing public grant type funding. They are notoriously difficult to obtain and require a large amount of time and effort which may result in it being unsuccessful. Grant awards will set out a requirement for future reporting and you will be expected to observe the reporting requirements for some years after. Bank Lending – some banks may be unwilling to lend the sums of money many businesses need to grow, especially when those businesses are at an early stage of development due to the high risks involved. It has been suggested that future models with more than one bank of a quasi-crowd fund may be on the horizon! Venture Capitalists often invest millions of pounds in a company. The money is normally put up by pension funds, insurance companies, banks and investment funds. They look for very good management, operating in a market that is either very large or is growing fast. The funds want to invest in companies that could reach significant profits within three to four years. Business Angels – before the arrival of crowd funding to find business angels you had to reach them through your own contacts or to approach them via a business angel network. Sometimes these networks would be highly secretive and charge fees to the investor and the entrepreneur. The levels of advice they provided for the fee varied widely, from offering pretty much none at all to the entrepreneur getting investor ready. Angel investing differs from crowd funding in that one or more investors may get involved in your business on a day to day basis. In the crowd, the involvement of funders is likely to be much more remote
Benefits of crowd funding The great promise of crowd funding is that it offers some advantages that other forms of financing do not. This means that more worthwhile businesses get funded and the people investing have more choices about how and who to do it with. In a world in which financial innovation has come to be associated with greed and dishonesty, it’s a welcome change!
- Crowd funding allows you the opportunity to access funding from investors who have an inherent interest in making your project or business a success.
- Crowd funding engages consumers in shaping and influencing what they want produced. Early engagement also supports a feeling of added ownership where backers in partnership with the entrepreneur have a stake in trying to make the campaign successful.
- While the crowd can be an excellent source of funds, in many cases their commitment or interest in what you are doing will motivate them to give you other forms of assistance. This can be in form of mentoring or feedback, marketing the project to others or assisting with specific task.
- By giving investors more of a role in carrying due diligence, and automating more of the funding process, crowd funding reduces the transaction costs of getting capital to entrepreneurs, making finance cheaper.
- Entrepreneurs come up with less initial capital from themselves, friends, family, and angel investor
Risks of Crowd funding Crowd funding has the power to change funding in a whole range of ways but we shouldn’t assume it will transform the world overnight. If crowd funding is to achieve its potential, there are a few key challenges to consider:
- Risk and regulation; as crowd funding grows in both scale and scope, it makes the requirement for some form of oversight more important. This is particularly true of equity crowd funding where unsophisticated investors will be backing risky ventures in many cases driven primarily by the expectation of making a financial return. But at the same time, the Government should not overreact and introduce the kind of heavy handed regulation likely to stifle small new platforms.
- Setting valuations – Entrepreneurs need to ensure they value their business correctly in order to decide how much equity to offer for the amount of equity they are seeking. This is important to ensure the entrepreneur gets a fair evaluation for their business while ensuring shares are not too expensive.
- How web savy are you? If you know nothing about the web and especially social media, you will find crowd funding very challenging.
- Launching your crowd funding campaign to early: you must get to know your market before launching a campaign. Specifically, you must understand who your target market is, what motivates this market to engage with their product/brand and how to best communicate and engage with them.
- Underestimating the work and time required managing a fundraising campaign;the work involves generating momentum by tweaking and launching new perks, responding to questions and suggestions from supporters, keeping social media activities running and trying to win mainstream press coverage. Until your campaign target is within reach, the pressure is on constantly to do more of everything.
The more research I do around crowd funding the more inspired I am by the potential that crowd funding offers both to people who need money and to those who have it and want to put it to good use. The big challenges that face crowd funding, such as regulation, are being addressed, if not yet completely resolved already.
As Commercial Funding Manager at Staffordshire University this is a model that we are currently investigating in support of Research and Development, technology transfer and business start-ups. I don’t believe that crowd funding will ever replace banks, grants or other traditional risk investment but I hope to use it as a means of raising money that we can leverage with other public and private funds to help de-risk the investment opportunity.
It would be great to hear from peoples experiences of Crowd Funding.
To find out how businesses can collaborate with Staffordshire University please click here http://www.staffs.ac.uk/for_business/
To find out more about me and my contact details please click here http://www.staffs.ac.uk/staff/profiles/nl6.jsp