200 years of evolution: From the Statue of Liberty to KickStarter
“2012 was the year of the crowdfunding boom.” True, and the trend does not seem to be slowing in 2013. Over the last 4 years, crowdfunding has grown at 46% CAGR1 and was included on a number of trendlists as a key area to look out for in 2012. This said, it is by no means a new phenomenon.
Way back in the 1800’s Joseph Pulitzer raised over $120,000 (equivalent to $2.3 million) from New Yorkers willing to contribute to the building of the pedestal on which the Statue of Liberty now sits. In return for contributions of $1 or more, Pulitzer offered every donor a miniature model of the statue.
Today, crowdfunding is used to raise resources for a vast array of reasons, from starting a business or publishing a comic, to giving aid to people affected by natural disasters. On the back of this growth and diversification, four alternative crowdfunding models have emerged.
- Donation: The donor does not receive any tangible reward (e.g. www.gofundme.com)
- Reward: The donor receives a token of appreciation (e.g. www.kickstarter.com)
- Lending: The lender receives interest on the money lent (e.g. www.kiva.com)
- Equity: Lenders receive an equity stake in the business (e.g. www.seedrs.com)
“There are particular challenges for each model – but an increasingly professional set of available services signals a shift to the edge of mainstream”
Friends, Family and the Equity Gap
Should we be surprised that crowdfunding has taken off in such a spectacular way? Collectively, raising US$1.5bn2 in a year is impressive, however it only hints at the potential on offer.The rise of crowdfunding platforms and the evolution of the 4 models can be seen as a broadening and deepening of the social network revolution.
It’s an evolutionary step in the worldwide connectivity which we all now take for granted. Why share photographs and sell your handicrafts to an ever-widening group of people…but not ask them for funds when launching your start-up?
Social networking gives budding entrepreneurs the visibility needed to create a buzz around their new product – increasing consumer exposure, allowing for product testing and giving them the opportunity to access funds that are not normally available to them. It is increasingly clear that crowdfunding plugs the ‘equity gap’ between friends & family and business angels or venture capitalists.
Many start-ups tend to rely on close relatives and friends for funds up to a certain point, there is then a void before business angels or venture capital firms will take the plunge. Crowdfunding overlaps at either end of this gap and gives entrepreneurs the initial funds needed before progressing to the second and/or third round of investment (if needed).
As the name suggests, the growth of crowdfunding would not be possible without the participation of the crowd. There are enough consumers out there who want to ‘be a Dragon’. Investing in small start-ups is attractive to many people with spare cash looking for that ‘feel good factor’. By investing in a small business in return for a pre-release or an equity stake, investors not only satisfy their emotional needs but are also able to avoid the high transaction charges typically associated with investing in small, private companies.
“In short, crowdfunding plugs the ‘equity gap’ between friends & family and business angels or venture capitalists.”
Challenges: Laws and Lotteries
Crowdfunding faces key challenges which will need to be overcome for platforms to continue growing and become the fully-fledged ‘alternative’ funding vehicle it aspires to be.
Legislation presents the most obvious barrier. This is especially true of equity-based crowdfunding where the share return model presents the biggest obstacle. Governments are, however, working to overcome these key challenges in a drive to stimulate small businesses. The Obama administration passed the Jumpstart Our Business (JOBS) Act while, in Italy, the Monti government passed the Decreto Creciata. Fundamentally, both bills are aimed at exempting small businesses from certain regulatory requirements and increasing the number of permitted shareholders.
Not all challenges and barriers are so clearly defined. Crowdfunding is not yet perceived as an investment vehicle, with 95% of start-ups unable to reach their original revenue projections 3 and only a tiny minority making a significant profit. Although this will not affect reward and donation-based platforms, it suggests that equity-based crowdfunding may be more of a lottery, with the restricted prospects of seeing any real return affecting the credibility of crowdfunding platforms in the face of more serious investors.
“Can crowdfunding give investors a steady stream of return… or is it more of a lottery?”
Looking forward: Onwards and Upwards
Where does the future of crowdfunding lie? With governments keen to stimulate small businesses,consumers wanting to help start-ups and participate in cutting-edge projects, and entrepreneurs increasingly looking for alternative funding, the future can best be described as
“fundamentally well supported on many fronts”.
Evolution is by no means a fast process and crowdfunding already has over 200 years’ worth of experience to build on. The four models should by no means be seen as the final steps. BD Bacata, Colombia’s tallest tower, is funded by the ‘crowd’ in return for a share in the building – to name but one example of innovative and large scale crowdfunding. Will this diversification continue? So long as the crowd is willing to fund, businesses will turn to them for help. With increasing government support it seems evolution and innovation will continue to thrive both on and within the platforms.
1 Crowdfunding Industry Report, www.crowdsourcing.org,2012
2 The Venture Crowd, NESTA, 2012