Crowdfunding is one of the hottest business topics of 2013. In 2012 all forms of crowdfunding raised $2.7b – an 80% increase from the $1.5b raised in 2011. Massolutions, a consultancy, estimates the global market will increase another 81% in 2013 to $5.1b. A big component of this growth will come from the crowdfunding activities of startup companies. It is important for exempt market dealers to understand the application of the various models of crowdfunding to the funding lifecycle of startups in order to identify and capture emerging business opportunities.
Social Media Makes Crowdfunding Work
A major component of crowdfunding is the use of social media technologies such as Facebook, Google+, Twitter, Pinterest, etc. to help find and engage a crowd of supporters for the project. This usually involves telling the project’s ‘story’ by creating a ‘campaign’ for a project on one of the crowdfunding sites such as Kickstarter, FundRazr, Indiegogo, RocketHub, etc. Friends of the company/project are initially asked to make contributions and, most importantly, to share the campaign page and therefore the story with their social networks. As the campaign spreads through social media, potential supporters are exposed to the story and can also make contributions. After they make their contribution, they are encouraged to share the story with their social networks distributing the campaign to an ever expanding network of potential supporters.
Rapidly Emerging Market
Crowdfunding is evolving rapidly. As of this spring, there were 813 companies identified by Massolutions in the crowdfunding market space. Many of these companies did not exist in 2012. Among these companies there are many innovative business models attacking and expanding the market. These models currently divide mainly into two major funding models and three major categories of offerings.
Major Funding Models
The two major funding models are:
Keep It All (KIA) – all contributions to a project are available to the company regardless of whether or not the campaign goal (targeted amount of funding) is reached.
All Or Nothing (AON) – contributions to a project are treated as pledges and are only available to the company if the goal is reached. If the campaign does not reach its goal, all pledged contributions are cancelled and no money changes hands.
Projects determine which of these two models to use based on their financial requirements. If a project can benefit from even a portion of the target funds of a campaign, it is a good candidate for a KIA model. If a project requires at least a set amount of funding to proceed, it is best to use an AON model. The major benefit of the AON model is contributors will not pay anything if the project does not cross its minimum funding threshold. This flexibility removes the financial risk of running the campaign when it is not clear that adequate funds can be achieved.
Categories of Crowdfunding
The three major categories of crowdfunding are:
Donations / gifts
Rewards / presumer
Regulated / securities
The first category is essentially the traditional charity model where a donor makes a contribution to a project with little or no expectation of return. A recent innovation in this model means it is possible for an individual or a business to accept gifts in a similar fashion to what traditional nonprofits and charities have been able to do. This model has been used very effectively for individuals suffering tragic circumstances such as critical illness, accidents, losses from fire, etc. but sometimes even by entrepreneurs launching their business.
In the second model, a contributor to a project can select one or more rewards or perks for their contribution. When this reward or perk is the product or service offered by the company and the product or service is not yet available but will be developed with funds from the campaign, it is known as a “presumer” model (from blending the words “prelaunch consumer”). The most well-known company offering a crowdfunding system in this category is Kickstarter. Canada’s FundRazr is an innovator in this space and known for the community building aspects of their solution.
In the third or regulated model, the project offers some form of regulated securities: debt, equity or royalty agreement. Contributors (actually investors) execute simple securities purchase transactions through the crowdfunding system and are subject to much more strenuous identity and financial checks. A major feature of crowdfunding in this model is that prospective investors frequently contribute industry and financial expertise and will share due diligence information with ‘the crowd’ both before and after making their investment. The JOBS Act in the US and various crowdfunding initiatives under consideration by the provincial securities regulators in Canada are designed to enable and regulate this third model.
Company Funding Lifecycle
Startup companies typically move through a funding lifecycle and may benefit from all three categories of crowdfunding along the way.
In the very early startup stage, the entrepreneurs creating the company may use the Donations model to acquire enough ‘love money’ from friends and family to launch the formative stage of the company. Funds raised in this stage using this model are usually quite low: around $10,000.
In some cases, the company may have a strong enough brand or brand potential to use the Rewards model to raise funds. In this scenario, the company can provide a variety of tangible and intangible rewards to contributors. For example, it is common for companies to use crowdfunding to sell swag (company branded t-shirts, mugs, lunch with associated celebrities, etc.) to raise additional funds. Funds raised in this manner may reach as high as $50,000.
As the company reaches the stage where it has a working prototype and now requires funds to finalize the design and produce a commercially acceptable product, it is a good candidate to use the Presumer model. In this scenario, the company offers one or more configurations of its product or service to consumers who pledge to pay if the company meets or exceeds its funding target. If the company pre-sells enough to cross the threshold, the pledges are collected and the company receives the money to begin production. At some point in the future, the company (hopefully) ships the product or service. Funds raised using this model average around $250,000 but some noteworthy examples such as the Pebble Watch have raised millions. The presumer model is the ideal way for many companies to bootstrap themselves because they are essentially taking revenue early and not diluting company ownership via an initial equity offering. This preserves securities sale options and increases the value of the company for later funding rounds.
Presumer Not For Everyone
Some companies are not well suited to a Presumer model because of their business model, their business (as opposed to consumer) customer focus, the amount of research and development time it will take to perfect their product and many other factors. For these companies and for companies that have passed through the early stages of their development and need to raise larger amounts of money, the securities crowdfunding model may be appropriate.
There are significant initiatives underway at the various provincial securities regulators across Canada with the goal of making it easier for companies to raise money at early stages. There are proposals in place to utilize crowdfunding of securities as part of those initiatives. In a similar way, the SEC in the US is working on the regulations for implementing the crowdfunding provisions of the JOBS Act.
The promise of securities crowdfunding is that companies will be able to cost-effectively raise smaller amounts of money by tapping into community support they create from effectively promoting their offering via social media. In order for this to work well, companies offering securities need to attract both accredited and unaccredited investors and build them into an active, engaged community. Early entrants into the market such as CrowdCube in the UK report that the average deal size on their platform was around $250,000 with a large number of deals well under that range.
It is helpful to think of crowdfunding as providing a continuum of funding options for companies as they move through their development lifecycle and potentially onwards to a more traditional IPO. A key component of any successful crowdfunding campaign is the creation of an active, engaged community of supporters. Companies that build this community early in their lifecycle will be much more effective at raising capital at later stages if they take their community along with them.
EMD Crowdfunding Opportunities
With this concept in mind, it makes sense that an EMD would advise a client to start a Donations, Rewards or Presumer campaign prior to launching a Securities crowdfunding campaign in order to seed the market and start to build the required community. Effective EMD companies will aggregate the communities of the companies they work with to provide a much larger target pool of investors and will use this pool to differentiate their services as they prospect for new customers. New offerings such as FundRazr’s CFaaST (crowdfunding as a service technology) allow EMD companies to host crowdfunding campaigns for their customers on the EMD website. This will drive EMD brand visibility and also help with new customer acquisition and deal flow.
Crowdfunding is exploding; new innovations are emerging daily
Crowdfunding offers EMD customers new options across the entire continuum of their funding requirements
Crowdfunding provides many mechanisms for building and growing an EMD business over and above standard securities offerings
This article originally appeared in Exempt Market Update Magazine and was shared with Crowdfund Insider by the FundRazr Team. It is authored by Daryl Hatton, Founder and CEO of FundRazr.
FundRazr is a world leader in crowdfunding technology with customers in 18 countries and over $35M raised to date. We are actively working to extend crowdfunding benefits to the entire EMD ecosystem.
Daryl Hatton, founder & CEO of FundRazr, has extensive crowdfunding industry experience: http://ca.linkedin.com/in/darylhatton. He is active on the Crowdfunding Accreditation for Platform Standards Council: http://www.crowdsourcing.org/caps. He is also VP National Platforms for Invest Crowdfund Canada: http://icanada.nu/crowdfunding/.
For information about Fundrazr visit http://fundrazr.com
For more information about CFaaST visit http://poweredby.fundrazr.com