Crowdfunding 101

So, what’s going down in Startup town?

A lot my friends, a hell of a lot. Let’s start with something I’m massively excited about right now. Crowdfunding…

Crowdfunding is a way of connecting companies and projects that are looking for resources (primarily but not always financial) with groups of individuals like you and me AKA ‘the crowd’. First, let’s take a look at the different types of Crowdfunding.

Equity Crowdfunding — The Crowd invests in a company and get an equity stake (shares) in the company in return. Equity Crowdfunding is a hugely important type of Crowdfunding and I’ll cover it in more detail later. For now let’s just use the example of investing in Facebook or Google when they were just wee little Startups. Gasp!

Donation Crowdfunding — The Crowd invests in something because they believe in the cause. A cool example of this is the Sochi 2014 Winter Olympics. Without funding from their sports federations, many Olympians were unable to fund their trip to Sochi. So they raised the money via Donation Crowdfunding. Canadian Skiier Kim Lamarre was among them and ended up with a Bronze medal.

Debt Crowdfunding — The Crowd lends money to other individuals or businesses. You might hear “the suits” refer to this as P2P (Pier to Pier) lending. For example, you go on-line and browse a list of companies and individuals looking for a loan. You pick the one that you like and you get paid back over an agreed period at an agreed rate of interest.

Reward Crowdfunding — The Crowd invests in a business for a reward. Duh! ;) For example, I saw a film director I love with a proposal for a new film. I loved the idea, so I invested. In return I get to go the premier and I’ll receive a copy of the film, signed by the Director.

Like I said, Equity Crowdfunding is hugely important. It’s important because it changes something fundamental in the way our financial system works. To understand the change, you have to take a little stroll down history lane. Around the turn of the 20th Century in free market economies like the US, more and more individuals began to wield significant financial wealth. People like the Rockefellers, people with the kind of wealth that could help create new Startup companies, provide jobs and fuel growth. Regulators wanted to encourage this kind of investment but on the other hand, they needed to protect citizens from adverse risk and investing in private companies was a risky business.

Around about the 1940’s courts began allowing certain individuals to invest freely in private companies if they were considered an ‘Accredited Investor’. Depending on where in the world you are the definition of Accredited Investor changes slightly, but it largely comes down to your net worth. To help paint a picture of the Accredited Investor let’s take a closer look at some of the main criteria in The US and Europe.

US — An individual with a minimum net worth of $1 million — An individual with a minimum annual income of $200,000 (Or $300k between you and your spouse)

EU — An individual who’s made 40 investments in the last 12 months to a minimum value of €200,000 — An individual with a financial portfolio worth over €500,000

In the UK, that represents roughly 5% of the population. Consider that these benchmarks were laid down in the 80’s and are set to be adjusted upwards to account for inflation and it soon becomes clear the ‘Accredited Investor’ test is more an accreditation of a person’s bank balance than of their ability to invest. Being an Accredited Investor isn’t about your knowledge of investment or education in finance or even the basic information you have available to you. It’s the $ you drop on the desk. It’s the £ you pack into your pocket. It’s the € you yield or how many ¥ you’re worth. It’s money.

Here’s another point to consider, a pretty messed up point if you ask me. Let’s say you’re an Entrepreneur with a great new Startup. You’ve got off the ground thanks to a small but loyal customer base and with the help of some Angel Investors you’ve got most of the money you need for the next stage of growth. But you’ve still got a few shares left to sell and you’d like to offer them to your customers, Joe public, so they can share in the spoils of your success. They’re not ‘Accredited Investors’ but they’ve loved and supported your idea from day one and can’t wait to see it take over the world. Well Mr Entrepreneur, if you pitch your idea to them that’s punishable with jail time. At least, it was in the UK until a few short years ago when the Financial Conduct Authority changed the rules. Well done to the FCA by the way.

Basically, when you look back at the relationship between budding Startups and Joe public, there’s kind of a Romeo and Juliet thing going on. We both know the odds of living happily ever after are slim and we know that the laws of the land forbid it, but we don’t care. We’ve got a thing for one another and it’s always felt a little unfair that we can’t explore that relationship.

Well brothers and sisters, Equity Crowdfunding might just be the Knight in shining digital armour that rides in to re-write the rule book.

There are a variety of Equity Crowdfunding platforms in the world right now but the number is growing… fast. A splendid UK example founded in 2010 is Crowdcube. When you reach their website you’ll see a list of projects of all types and sizes who are looking for X amount of investment in return for Y number of shares. Each project will give you the low down on their concept, the team behind it and how with your help, they plan to grow. If you find one you like, you can pledge to support it. The amount you can pledge will vary from one investment to another but it could be as little as £5 or an uncapped amount.

Keep in mind that each project has to raise at least 100% of the funding otherwise it can’t go ahead. Not all projects are successfully funded and if the one you pledged to support fails to reach its funding target by the deadline, the project is simply cancelled and no money changes hands. Assuming the project receives 100% of the required funding pledges by the deadline then congratulations, you’ve just helped to fund a new business! At that point, the money you pledged will be transferred from your account to the project, not before. That’s a really cool feature of Equity Crowdfunding. Your money will only ever go into projects which have succeeded in getting at least 100% of their funding.

For Startups, Equity Crowdfunding is obviously a great way to raise money. Rather than only being able to secure funding from 5% of the population, you’re opening up the other 95%. Each one of the 95% might only invest £100, but there sure are a lot of us! Equity Crowdfunding is also a great way to allow individuals to get involved with exciting Startup companies at the early stages. It opens up a huge new area of personal investment and gives individuals more control over their money by allowing them to invest straight into the projects they care about. But more importantly than that. Perhaps, most importantly of all. Equity Crowdfunding gives us a seat at the table and a share in the game. It gives each of us the chance to help build the companies of tomorrow and improve our lives in the process. That’s something very special. Something I think a lot of people have been crying out for a very long time.

Equity Crowdfunding might just be the best thing to happen to Capitalism since Capitalism. It could help stimulate innovation, create jobs and re-balance the distribution of global capital to better reflect the passions of society. Equity Crowdfunding could diversify the Boards of tomorrow’s companies to better reflect the diversity in the working population. Equity Crowdfunding could even help to bridge the gap between the 1% and the 99% and democratise the financial world in a way never before seen.

You may have noticed, there was a lot of ‘could’ and ‘might’ in that last paragraph. That’s because it’s too early to tell just how revolutionary Equity Crowdfunding may be. Like so many things it has potential but right now, it’s still a very fragile little creature. The way Governments and Regulators react will have a huge impact and much like a Startup, the odds are against it. But when I look at Equity Crowdfunding and Crowdfunding in general, I believe it can make a difference. Crowdfunding gives me hope that the future of commerce isn’t just another slice of history repeated. What I see in Crowdfunding is the potential for something new and better that I can truly get excited about and I think, that’s worth writing about.