Is crowdfunding in healthcare the right tool for your startup?
Healthcare is one of the most exciting markets and the internet offers an inexhaustible source of potential customers for startups in Digital Health. Entrepreneurs are keen on finding investment to push their digital product or service to the market. Sooner or later the startup founders stumbleupon crowdfunding, impressed by the opportunity of the vast exposure and success stories about million dollar closing rounds. Is crowdfunding the right funding instrument for your ehealth startup? In this article you’ll learn about the different crowdfunding types, the pro’s and con’s of this financial instrument for your startup.
Definition of crowdfunding
Crowdfunding refers to a person or a startup going public and raising money for a specific project. On crowdfunding websites the fundraiser connects with the funding investors. The investors can be anyone from all over the world who have registered at the specific crowdfunding platform, unveiled their identity to the platform operator and provided their bank account or credit card details to enable a money transfer.
Overview of the crowdfunding market in Europe
In the U.S., the home of crowdfunding, platforms like Kickstarter and Indiegogo helped crowdfunding make a breakthrough. Projects such as the consumer wearable Pebble received around $10 million (EUR 10.5m) in funding on these platforms in April 2012. Donors usually receive a sample of the crowdfunded product. By the end of 2016, Pebble‘s intellectual property has been successfully sold to Fitbit and some former team members continue working under the new ownership and brand. For a startup this sounds like a typical journey towards an exit. In Europe, crowdfunding is still small but growing fast. In Europe there are about 510 crowdfunding platforms. In Germany startups can choose among 87 different platforms.
In 2015 crowdfunding projects raised €4.2 billion (4.423.755.000.000 USD @ 1.05 USD to 1 EUR) through crowdfunding platforms in the EU, compared with €1.6 billion (1.685.240.000.000 USD) in 2014. Looking into the details, in 2015, €4.1 billion (4.318.427.500.000 USD) was raised through crowdfunding models with a possible financial return for investors — mostly through equity investments or loans. Although crowdfunding is possible in all European Union member states, only a few countries are pushing it to the max: Brexit-candidate United Kingdom has by far the largest amount raised (EUR 89 million = USD 93,7 million) in number of projects funded through crowdfunding according to data from 2013–2014, followed by France (EUR 19 million = USD 20 million) and Germany (EUR 18 million = USD 18.9 million). Not all investors who participated are registered in the countries mentioned above, the data focuses on the money that circulated in these years. It does not imply successfully funded projects.
A closer look on crowdfunding types: donation, equity, lending.
Donation-based crowdfunding describes a campaign over a specified amount of time, where users donate a certain amount of money to a person or startup without receiving any equity or anything money-wise in return. Donors get rewarded by special perks like an early subscription that offers exclusive benefits to the person who donates. Donors receive a symbolic return, for instance a limited edition product bundle, but no shares in Your startup.
Equity-based crowdfunding lets the investor own a piece of the company. During an equity crowdfunding round, a startup issues equity — shares of its company stock — to participating investors on a proportional basis. The investor gets the company shares in return for his or her investment. The investments are usually from 2-digits up to 4-digit numbers. The equity deal can be a silent partnership or profit participation rights.
Lending-based crowdfunding allows entrepreneurs to raise money in form of loans they later pay back via interests usually linked to the revenue or profit of their business. In Germany, lending-based crowdfunding has become popular with a so-called subordinated loan offered on the crowdfunding platforms. Simply put, it’s a loan from the crowd. During the crowdfunding campaign the startups tries to acquire as much money as possible from the investors. The crowdfunding platform acts like the marketplace that unites both parties: the startup as the borrower meets the investors as the lenders. This type of loan is very similar to a bank lending a company funds.
Depending on the conditions, investors may also receive a profit distribution once the startup gets acquired (exit).
What motivates investors?
Three main reasons motivate investors to invest into your startup. Believe it or not, the first and foremost reason is purely money driven. Yes, investors want to make money with your business. Like in a diverse stock option portfolio, your startup is one tiny mosaic in their portfolio strategy to increase their return on invest. According to the Boston Consulting Group (BCG) matrix, your startup might start as a question mark with a highly innovative product in a new market, then move to a rising star that turns either into a cash cow (hopefully) or a poor dog (hopefully not). The other two reasons are pretty well summarized by Slava Rubin, co-founder of Indiegogo: „The second reason is for the joy of the process. And the third reason is to create a social good, whether you’re investing in someone you’re already familiar with or contributing toward a broader cause.“
The platform operators would also like to earn money for providing their platform and services like choosing the right startups and bringing them together with potential investors. Their business model is basically service fee-based. Your startup team should carefully compare the terms and conditions of different platform operators and also contact entrepreneurs who have completed a project either successfully or unsuccessfully on one of the platforms, because the differences in quality are huge.
Lending-based crowdfunding in Germany — how much can you raise?
It’s the nature of the game to keep as much equity as possible within Your startup founding team to have full control over Your business’ direction. From that perspective, lending-based crowdfunding seems to be more attractive than the equity-based one. If you aim for lending-based crowdfunding, the process of fundraising itself is regulated by the same laws that govern financial institutions. That means, if you like to raise less than EUR 2.5 million (USD 2.6m) in Germany, you are kind of safe from extra costs, because you don’t have to publish a prospectus. With more than this, you are in the duty of prospectus publishing.
A prospectus is a disclosure document that describes a financial security for potential buyers. In the contrary to a business plan, it provides much more in depth information based on a regulatory framework by the European Commission and is usually required when a company prepares for an IPO.
Looking into the first blossoms of crowdinvesting in Germany in 2012, the crowdfunding platform owners developed equity-based investment deals like silent partnership or profit participation rights. Investors really had a small stack in the company they invested in. Due to laws in finance, these deals could only work without a prospectus requirement for funding amounts equal or lower EUR 100.000 (USD 105.327). But how good can you market a EUR 100.000 funding story if your platform business is based on the number of fees for projects successfully initiated on your crowdfunding marketplace? This is why subordinated loans found their way into German crowdinvesting, because the amount that can be raised without the obligation of a prospectus is up to EUR 2.5m (USD 2.6m) in Germany. It’s the ‚Prospectus European Directive’ that specifies the information which has to be transmitted to investors for funding targets over EUR 5 million (USD 5.2m). The prospectus directive has been established to provide the highest amount of transparency and therefore a minimization of risk for investors.
Throughout the EU, funding targets of less than EUR 100.000 are exempted. UK has exempted all funding below the EUR 5 million mark (per issuer in a 12 month period), while Germany and France both currently use the minimum fund ceiling of EUR 100.000. Germany, culturally known for its risk-aversity, has come up with a new regulation for private investments on lending or equity-based crowdfunding platforms. Private investors can only invest up to EUR 10.000 in each project they like to support in its economical growth.
What still remains unclear is the process how startups are chosen to start their project on specific platforms. Currently there is no profound due diligence process on platform side that could protect both parties: on the one hand the startup in wasting too much time and money in an unfruitful campaign and on the other hand the investor in understanding the product or service, the market and the team dynamics within the founding team. Equity and lending-based crowdfunding can lead to a complete loss. But hey, no risk, no fun!
Crowdfunding remains a high-risk investment
One example of a too-good-to-be-true story without a proper due diligence beforehand happens to the investors of the German lifestyle food startup „kyl21“:
In their campaign copytext on the German crowdfunding platform ‚companisto‘ the startup claims to be the first company to produce molecular ice cream building its own cooling technology system „kylator“ for mass production. In the contrary to regular ice cream, their specific cooling technology allows them to produce much more healthier ice cream with less sugar while natural ingredients like vitamins are conserved. Healthy food for smart people with a good taste, ready for mainstream aka lots of buyers — what a lovely approach!
With a compelling story, an innovative concept and the impression that the proof of concept convinced already lots of customers thanks to great PR, the startup raised EUR 940.650 (USD 990.763) within a blink from 1978 investors in April 2014. Besides the description on the crowdfunding platform and a few more updates, by now not much more business insights have been revealed. The crowdfunding platform owners themselves earned a 10% fee (€94.065) for the promotional services offered to push the funding for this project on their marketplace.
Once the money had been transferred to the startup, 1978 investors are still waiting for updates regarding their investment. And have to swallow a bitter pill: one of the core founders left the company to start a new venture with a similar product called „Veru“. Has there ever been an exclusion of competition articulated in the crowdfunded startups’ articles of association? However, one of the core founding team members from ‚kyl21‘ kept his promise he gave all investors on the platform: „In 2016, we plan to open our first American location in Los Angeles.“ What he didn’t mention: the US business is not run by the company that received all crowdinvestors’ money. What’s the function of a company that got the crowdinvestment but isn’t used for generating revenue and making profit?
Nowadays companisto has done some touching up to reduce the risk of losing investments. Startups now only get 2/3 of the raised funding sum and after 6 months of the first transfer the investor crowd has a voting right to agree or disagree to the transfer of the final 1/3 of investment. This puts the startup into a reporting duty how the money is put into action to reach its promised goals.
So, what is the secret sauce of a successful crowdfunding campaign? The most successfully crowdfunded startups seem to be the ones with the most compelling story promising an added value that even a child can grasp within a minute. The more tangible the product or service is, the higher the chance to become successfully funded. But the storytelling itself does not include the ingredients for a proper business. Besides knowledge of the market, it’s mostly the commitment of the founding team that sets the course.
How crowdfunding in German healthcare leads to success
One success story in German crowdfunded ehealth startups is the story of doxter. Based on business concepts from the US like zocdoc, doxter is an internet platform where doctor’s appointments can be scheduled online 24/7. The doxter startup was the very first companisto project ever when the platform launched its services in 2012. 421 investors backed the team with an investment of €100.000. In November 2016 the startup announced the successful exit to ‚Doctena‘, a VC backed competitor from Luxembourg and market leader in Benelux countries. Over 4 years, the doxter team acquired more than 2.000 German physicians in 5 major cities running 20.000 online appointment bookings per month. Doctena itself has 1.500 physicians united on its platform and is eager to conquer its European competitors ‚doctolib‘ and ‚jameda’ now by storm.
The number of acquired physicians over four years gives an impression how tough the everyday job in sales and marketing can be for a digital health startup in the German healthcare market. High growth performance in a regulated market is a challenge. Healthcare entrepreneurs are forced to be extra assertive. Doxter published updates to its investors on a regular basis and kept an open dialogue. Since the exit the crowd investors can look on a nice return on their investment thanks to the dedicated and focused doxter team.
Why healthcare is a lucrative market for Digital Health startups
Healthcare is profitable market. For 2016 the global eHealth market is forecast to be at around USD 25.39 billion (EUR 24.107.481.960) with a continuous growth. The revenue in the German eHealth market in 2016 was USD 342.5 million (EUR 325.199.392) strong. It’s about to be transformed by digital technology like other industries, eg media. According to the World Health Organization (WHO) eHealth aka digital health is defined „as any activity in which an electronic means is used to deliver information, resources and services related to health . It covers many domains, including electronic health records, telehealth, mobile health (mHealth) and health-related use of e-learning for patients as well as health-care professionals, health analytics and “Big Data“”. Due to its strong regulations and health politics involved, it might take longer to grow your business but it’s definitely worth it. In the end, it’s about aiming for best possible health outcomes which can affect you beneficially in the near future as well. Think of the growing aging population, the increase of chronic diseases and its digital management via patient monitoring for preventing disease progression or Big Data and genomics are only a few topics that can be tackled with technology based products and services.
Now with all this knowledge, is crowdfunding the right tool for your startup? Depends on what You would like to achieve and at which stage you are with your business.
5 reasons for your startup to avoid crowdfunding in healthcare
1. Your business case gets stolen by competitors
First and foremost crowdfunding isn’t for the faint-hearted. Despite the fact that crowdfunding has the ability to attract investors from all areas, the flipside comes along with the transparency of your startup business case that is presented to literally everyone who ever registered on the crowdfunding platform. When your startup isn’t in the market yet, the chance that a competitor steals all your carefully selected business data is much higher than attracting a large number of investors.
2. Your own Startup readiness
Before You consider crowdfunding, all relevant business data including competitor analysis, target customer segments, go to market tactics plus growth strategies have to be assembled, timed and clearly written into a business plan for internal use. If you haven’t done your homework You should clearly stay away from crowdfunding at that stage in your startup journey.
3. Time is Your most valuable resource. Your. Most. Valuable. Resource.
The time invested in the preparation for Your crowdfunding campaign is about 2–3 months which is in most cases equal to the time invested for preparations for investor meetings. Once Your campaign is running, your potential micro-investors will ask questions and You and your founding team will be 24/7 busy with fundraising and engaging with your crowd. Outsourcing the fundraising is crucial, because investors want to be in touch with the core business team they invest in. Also, the CEO and other co-founders will end up acquiring literally everyone in their network to invest into their startup. Your time spent on fundraising €5 or €5000 is the same. Your team will not have enough time to fulfill its daily tasks, because everyone is blocked by the requirements of the running campaign.
Once You have been successful, your investor crowd requires regular updates and a healthy measure of relationship management. Even if someone only invested 5 bucks into your startup, an unanswered question in the crowdfunding community board can cause You a PR disaster. Prepare to have someone taking full ownership of the investor relations including preparing the reports on your startup growth and future investment plans.
4. Legal constraints
Some platforms require a business plan much more detailed than the manageable description that is going to be shared with Your potential investor audience. With every lean startup approach, Your business model can change and Your startup pivots. This can lead to a conflict with the legal bindings of the contract agreed between platform and your investors if Your business plan at that time was used as the legal document to fulfil investors’ interests. Some platforms have contract rules that allow them to participate in your future funding rounds and earn a percentage from it even if you were unsuccessful in raising your expected funding sum. So make sure you understand the fine print and its consequences for the bigger picture of your funding roadmap.
5. A failed campaign can cause you trouble in finding Angels or VCs
Crowdfunding requires a well performed PR and marketing campaign in order to close your funding. Your audience are mostly micro-investors who have not the same insights as Business Angels or VCs who actively invest in your market segment. Your PR noise might attract the attention of potential future investors. If you fail, you will fail with lots of PR noise and they have a reason to stay away from you. They are still waiting that You are going to find that one and only lead investor whom they can follow.
5 reasons to choose crowdfunding in healthcare
- Presell your product or service to Your future customers
Launching a crowdfunding campaign can bring you early adopters in types of your first customers. You can design specific product packages that investors can exclusively benefit from. Their pre-ordering can support you to drive larger volume orders with manufacturers or in case of software, sell licenses that guarantee a nice distribution of your service. The amount of pre-orders helps you to reduce your financial risk.
2. Higher product to market fit through investor driven feedback
When investors are part of your future customer segment, they tend to question product features and ask you tons of questions during your campaign. They can also be supportive in finding flaws in your business plan. The time of the campaign is Your ability to engage the crowd and receive comments, feedback, and ideas. Take them seriously, because these people really care about your product and want You to be successful. Through their market feedback you might discover a second profitable market segment or a new feature you haven’t thought of in your team. All you need to have is a prototype and your business plan. Before investing in manufacturing, You can include your audience in product development and iterate until you feel comfortable with the result.
3. Market validation
In your lean startup, your product or service adds so much value to an obvious problem that people are willing to pay for it. You have tested your product in your targeted customer segment with your startup marketing budget, now You can test your hypothesis with the crowdfunding swarm at low cost. Validating your business case will give you useful insights into the potential of your product roadmap. How does the crowd receive your product? Is the majority of your investors really your target demographic?
4. Attract new Angel investors and VCs
Professional investors like Business Angels and VCs use popular crowdfunding platforms as a sounding board for future market trends. If your campaign leads to a successful funding, you have much better opportunities to negotiate additional funding rounds with VC’s than before. Due to the exposure of popular crowdfunding platforms, the chance to be found by investors outside your network is much higher. Crowdfunding is a social form of fundraising by nature. Maybe you are able to turn down some investors to find a better deal with a VC who provides smart money for you: insight knowledge and growth opportunities for your startup.
5. You remain the driver in your driving seat
With all the crowdinvestors on board after a successful campaign, you still remain the driver in your driving seat. While institutional investors want to sit with you around your table, deciding on your startup’s direction, with a crowdfunded loan or equity share you have full control over your startup’s direction and remain the driver in your driving seat.
It’s up to you to decide if you prepare your startup for a crowdfunding campaign or choose the path of classic investments like Business Angels, Venture Capital, governmental funding or bank loans. Whatever happens, please keep in mind: it will take longer than you think and it will likely cost more than you expect.
Now that you know about the pro’s and con’s, truly ask yourself: is your startup ready for this type of investment and are you willing to take this extra mile? If one of your co-founders is not fully committed, don’t go for it. Listen to your co-founders’ concerns or you risk an ongoing conflict. If you find yourself in one of the points described in the con’s, you better sit down, reshape your prototype and listen to your test-users feedback instead of going public with lots of noise. Crowdfunding in healthcare works as an additional tool in marketing, aiming for new users. It’s not suitable as a first investment round. Never choose crowdfunding because you are running out of money. The money spent on a crowdfunding campaign puts some extra burden on your bank account which will stress you even more.
Remember: the amount of people you are going to ask for an investment will affect your whole personal and professional network. Everyone will know and not everyone will invest. Ask your network for an angel investment instead, work on your product and once you like to increase your userbase, you might choose the wisdom of the crowd. Register as an investor on your top 3 favorite platforms and monitor projects in your market to gain knowledge on the investors’ behavior. In which amount of time are these projects successfully funded or not? Because next time it could be you.
Juliane Zielonka is Managing Director of the startup accelerator program Startupbootcamp Digital Health Berlin and steering team member of the Health 2.0 Berlin chapter. She actively invests in Digital Health startups. In 2015 she ran a lending-based crowdfunding campaign for her own medical startup. At halftime — after two of four months of 24/7 campaigning — she stopped the crowdfunding after reaching 49% (EUR 103.000) of the funding sum, letting all investors getting back their money. If you like to know more about her entrepreneurial story, watch this video.