NESTA (the “National Endowment for Science, Technology and Arts” in the UK) has identified Crowdfunding as a high potential focus point for the UK economy. In 2012, £200 million of funding went through crowdfunding tools and the sector has the potential to grow significantly in the future. The UK is one of the leading markets for equity crowdfunding, enabling anyone to put as little as £10 to fund a startup (and own a small piece of equity).
CrowdingIn is a new site built by NESTA to provide entrepreneurs with information on the growing number of platforms for fundraising. Currently focused on the UK, CrowdingIn lists 31 crowdfunding sites. Apart from heavyweights players from the US Kickstarter and IndieGogo which operate mostly on donation models, CrowdingIn includes of the up and coming players in the UK doing equity crowdfunding including Seedrs, CrowdBnk, and CrowdCube, who recently raised £1.5 million for their business, using their own website.
Looking at the growth ahead, NESTA is doing research in the crowdfunding space. “Working the Crowd” (PDF), a recent report published by NESTA estimates that UK crowdfunding will quickly grow from its current volume of £200 million a year to £15 billion annually, replacing a big chunk of the £115 billion financial services industry in the UK.
Not only smalll rounds
Israeli crowdfunding platform OurCrowd, reported today that it has raised $350,000 out of a $12 million round for Zula, a cloud-based mobile collaboration platform for teams, started by angel investor Jeff Pulver. According to the press release published this morning, this is the largest transaction recorded using equity crowdfunding.
Several models, pick your poison
It’s important to understand the various models crowdfunding offers startups, to pick the most suitable one. There are different typologies, but CrowdingIn does a good job in dividing them into 4 categories, descriptions were quoted from this FAQ page:
- Donation crowdfunding (i.e. Just Giving) – The donation model of crowdfunding is a means for charities, or those who raise money for social or charitable projects, to gather a community online and to enable them to donate to a project. While most established charities facilitate this through their own website, crowdfunding platforms can be useful for smaller organisations and people raising money for personal or specific charitable causes.
- Reward crowdfunding (i.e. Kickstarter) The most popular form of crowdfunding to date has been the reward model which has grown significantly in the funding of creative, social and entrepreneurial projects. The model allows people to contribute to projects and receive non–financial rewards in return, usually operating a tiered system where the more you donate the better the reward you receive. The model often closely resembles philanthropy with the donation far exceeding the monetary value of the reward.
- Crowdfunded lending – (i.e. Funding Circle) Facilitates projects, individuals or businesses to seek loans from the crowd, with members of the crowd taking small chunks of the overall loan. Some platforms use credit scoring systems to accurately measure how risky individual loans are so lenders can choose an appropriate interest rate to charge. Lenders are usually attracted to the model by the financial return they can make from lending however some platforms offer social lending where low-interest or interest-free loans are offered.
- Equity crowdfunding (i.e. Seedrs) Equity crowdfunding allows funders to get a small stake in a business in return for contributing funds. A business will state how much capital it is seeking to raise and how much equity they are willing to give up. Funders then contribute a proportion of the overall sum and receive a proportionate number of the shares in the business in return. While many invest in the hope of getting a financial return should the business do well others invest to support the entrepreneur and what they are trying to achieve.
What about AngelList, CircleUP, Microventures, FundersClub and Gust?
In comparison to Europe, equity crowdfunding (and other alternative investments) is only permitted to “Accredited Investors” (AI) in the US. Here’s a simple definition of what that means:
“[Accredited Investor is… ] Someone whose net worth, either alone with a spouse, exceeds $1 million (not including the equity in her or his primary residence) or someone who has earned more than $200,000 (or $300,000 with a spouse) for the past two years and reasonably expects to earn more than $200,000 (or $300,000 with a spouse) in the current year”.
AngelList is no doubt THE leading platform in the US for angel investments (at least from a clout point of view), but it hasn’t yet established a strong international presence. In the articled “Follow the Money” published on Wired’s May edition, founder Naval Ravikant said:
In February angel.co/europe carried the details of around 6,000 startups, with more than 2,500 angels following them. Ravikant says that, since AngelList’s launch, 61 European startups — out of the 700-plus that have been highlighted — have been identified as the “cream of the crop” for investors, and more than 4,300 “introductions” have been made in Europe. He wants AngelList’s influence to grow over here, but he’s not sure about his strategy.
While the numbers are significant, European companies represent only 14% out of the 42,000 businesses featured on the site, many (if not most) are located in the valley, close to the angels investing in them. Even more local is Gust, a platform offering similar functionality to AngelList, but with a strong East Coast bias.
Despite the limitation to accredited investors only, several other equity crowdfunding platforms have done really well. AllthingsD estimates the following volumes of private investments on these platforms
- MicroVentures $16 million in equity crowdfunding investments
- FundersClub claims a bit over $5 million invested to date through FundersClub
- AngelList, $11.7 million raised this month (according to the homepage)
- CircleUp (“Invest in a consumer business you love”) – raised $10 million
When/if the JOBS Act passes (acronym for “Jumpstart our Business Startups”), any individual would be eligible to invest in startups, and you could expect these numbers to grow dramatically.
Startups be aware, Fools Beware
According to a the latest MoneyTree report by PricewaterhouseCoopers and the US National Venture Capital Association the share of global VC activity is shrinking. Activity levels last quarter reversed a trend of growth and declined by 12%. Case in point, 51% of Israeli VC funds made zero investments last quarter, bringing the total investments of Q1 2013 to $196 million (a number many other countries wouldn’t mind “slipping” to, but nevertheless a 29% decline from $277 million in Q4 2012.
Crowdfunding is an alternative financial tool for founders and they would be foolish not to learn more about its capabilities. It’s important to mention that crowdfunding is high risk – for investor and startup alike (in equity crowdfunding mainly). There is a signaling risk – what does it say about a startup if no one “followed” or invested in it. There is a governance risk – how can a startup conduct an investor meeting if it has 150+ stakeholders to alert?
FFF, or Friends, Family and Fools has long been the first line of contact with entrepreneurs, but usually the fools were either family or friends. These new tools potentially bring a lot of new “fools” to the market many of them “founders”- and they should take a note from the “buyer beware” book. The reality is, that the vast majority of these startups will likely fail to a certain degree. The dream of making millions, is the rare occasion, not the common one as it requires a major exit – either by acquisition (“trade sale”) or by IPO (we know how that is going…). FFF or not, investment requires due diligence (even if quick and dirty) into the product, the team and the market, and this is a step unseasoned investors are likely to skip unless educated on how to do that.
For startups, being “listed” and easily found is now an absolute requirement. A potential investor will look for information about a startup starting with search, and the more he or she are able to find out about the company, the more likely they are to get comfortable with the idea of pledging money into it. Platforms like Crunchbase or the new ILVenture directory (Israel-only for now) are great free tools for startups to adopt.
Raising money through crowdfunding is an exciting new frontier. I’ve personally seen startups at Campus that were able to complete their funding goals using these platforms, enabling them to ship a product to the market, sign deals and raise enough awareness to raise a bigger round from institutional investors. But as illustrated in the infographic above funding, the “picth goes live” and “public pledge money” are critical steps and preparation in this case makes the difference between success and the not-so-talked-about failure – only 43% of Kickstarter projects reach their minimum funding target. There’s plenty of advice out there – from NESTA’s 10 pointers to succeed in crowdfunding to”A primer for fundraising on Angellist” or this Udemy course on “raising money for startups”– ignore them at your peril!