The first universally accepted example of crowdfunding was back in 1885 when the New York World appealed to its readers to cover the shortfall in government funding for the Statue of Liberty plinth. Until the advent of the internet and social media, crowdfunding was largely overlooked. Then in 1992, The Vegan Society crowdfunded a documentary, and in 1997 British rock band Marillion raised £50K to underwrite their US tour. The principal of crowdfunding hasn’t changed much since 1885 or the 1990s. It’s a bit like debt collection but in reverse. Crowdfunding allows established and pre-revenue businesses to raise money from a large pool of backers (investors) they would otherwise struggle to reach. A common misconception is that crowdfunding is the last chance saloon when the banks aren’t interested. For many entrepreneurs, it is the perfect tool to birth an empire.
Types of Crowd Funding
Investors typically get shares or perks in return for their money. Shares generate income through a dividend declared at the board’s discretion. Perks and rewards such as discounts and pre-orders are offered in lieu of shares. Other types of crowdfunding give less traditional returns. When a cryptocurrency is launched, investors who funded the development get rewarded with Digital Tokens, which can be traded once the new currency goes live. In Peer-to-Peer Lending, companies crowdfund their borrowing instead of using a bank. Litigation crowdfunding involves contributing to prosecution costs in a class action suit where the claimants expect to receive damages. Examples include diesel gate and cell phone obsolescence. Donation-based crowdfunding is where individuals seek money for things such as medical bills, domestic emergencies, and community projects. Websites like GoFundMe have pioneered this form of charity.
Upwards of 1,500 crowdfunding websites and apps generate over $13 billion per year from investors. Everything from the arts to zoology can be crowdfunded. Websites are the focal point for potential investors and the all-important sales pitch. When the revenue target is met, the door shuts on new investors. Less than half of campaigns reach their target. If the cash raised falls short, some websites return funds to investors, whilst others will let the company keep what has been pledged. Crowdfunding websites take a commission fee, a management fee or both from each transaction. Launching a crowdfunding website is not as simple as uploading a picture and writing a few flowery sentences. The most successful campaigns involve videos, testimonies, and cross-platform advertising.
Research by CB Insights found that 35% of new businesses fail because there is no market need. With that in mind, crowdfunding provides a useful barometer of consumer interest to gauge whether the idea is worth pursuing. Being poorly advised or misinforming potential investors is a cardinal sin in the crowdfunding industry. In 2019 the FCA gave investors some protection against receiving unsuitable advice, but this falls short of the safeguards seen in other products like ISAs and mortgages.
The Art of Investing
Crowdfunding carries a high risk, low yield investor profile. No matter how big the opportunity, less than half will generate a meaningful return. Investors are only likely to see their money back if the company is sold or floated on the stock exchange. When perks and rewards are offered, seasoned investors lower their expectations in anticipation of design and development snags. The primary motivation for investors should be their contribution to a company’s mission or product’s success. Early investors may get the opportunity to engage with designers, provide product feedback and shape its development. Saying you contributed to the next big tech or trend carries street cred. Some people go to social clubs and churches for their friendships, others find solace in the communities of like-minded investors. Investor communities double up as customer bases and brand advocates. On Dragon’s Den, there is a good reason why the dragons stick to markets they know and products they like – familiarity lowers the risk. The same applies to crowdfunding. If you’ve never read a medical journal, chances are you won’t fully understand the merits of a eukaryotic chromosome thingamajig! Crowdfunding attracts the average person, the amateur investor who won’t give the balance sheet and patent a forensic level examination before parting with their hard-earned cash.
For some business owners, crowdfunding turns a dream into reality. For others, it signals ruin. The failure of any crowdfunded business is more in the public eye than a traditionally backed venture. For that reason, the directors, inventors, and branding are vulnerable to reputational damage to the point where the next big idea is doomed by association. When prototypes are issued to backers for testing or software becomes an open source for communal development, it becomes difficult to protect intellectual property. Exposing an idea so early on gives better-resourced competition time to catch up and steal the thunder by being first to market. We often hear about established businesses tapping investors for more money, and the same applies to crowdfunding. Repeated drives for funding create investor apathy, and water-down paid for equity. With so many investment opportunities and patchy global regulation, it’s not always easy to tell a genuine crowdfunding campaign from a fraudulent one. Businesses can be bogus, and causes can be cloned. Despite the screening processes of crowdfunding websites, scams can and do happen. They’ve come a long way from that ‘Nigerian prince’ promising millions. Launching a crowdfunding campaign is no guarantee that investors will come. To entice investors, you’ll need to compete with hundreds of other equally worthy campaigns on the same website. A golden ticket awaits those who get picked up by the national press. The back-office administration required to keep hundreds of investors happy is a tedious and exhausting one. Providing bespoke updates to a thousand investors who own 4% is much more work than keeping sweet an angel investor with a 40% shareholding.
Not all business failures are attributable to market forces and macroeconomics. The right product is doomed without the right people believing the same truth. Yogi Hamilton hypothesised ‘reality is there for the breaking’ and concluded ‘reality is what people see, not what is. In the same light, a marriage of inventors and investors only works if both continue to see the same reality.
The Dragonfly-Futurefön hybrid cell phone is one of the biggest crowdfunded failures to date, culminating in a painful divorce. Fundraising commenced in 2003 and went on to extract $5 million from regular investors plus $700K from crowdfunding. The company ceased trading in 2016. Contrary to the inventor and investors’ reality, there was little evidence to suggest the cell phone was anywhere close to completion. The inventor is now serving 20 years in federal prison, having been found guilty of 12 counts of fraud, including misleading investors.
Broken businesses hit the headlines, but there are some noteworthy British success stories. BrewDog has raised over £30 million since 2007 from circa 70,000 investors enabling the brewery to develop new products and revenue streams. In 2015 Camden Town Brewery raised over £2.7 million from crowdfunding. Less than a year later, they were acquired by the owners of Budweiser. App and pre-paid children’s debit card provider GoHenry have raised over £6 million through crowdfunding to date. In 2015 tech firm JustPark raised £3.7 million from crowdfunding to develop their parking space rental platform. Job search engine Adzuna previously raised over £2 million from crowdfunding.
Banking on Stupid
When done right and the stars align, crowdfunding can fulfil the founder’s dream and exceed investor expectations. Crowdfunding normally involves start-ups which are, by definition, high risk. When a company fails, shareholders rank below creditors in the pecking order of dividends, and their shares effectively become worthless. Try as they might, there is nothing a debt collector can do to recover share capital when a business folds. When looking to invest, you’ll see some genuinely brilliant ideas worthy of your time and money. You’ll also see terrible concepts like a chocolate USB keyboard or braille traffic signs! The onus is on the investor to do their due diligence and accept the risks. Whatever you decide, remember that banks and venture capitalists invest to make money, whereas crowdfunding backers invest to make a difference.