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
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:
1. 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.
2. 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:
1. Donations / gifts
2. Rewards / presumer
3. 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 are ‘investors’ who 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.