It’s transforming the prospects of small businesses, but it’s still early days for crowdfunding in the UK.
By the middle of this month, the Scottish National Party had raised nearly £35,000 on crowdfunding website Crowdfunder. It’s not the only party to turn to crowdfunding to bankroll its General Election campaign – over the past three months, 64 Green Party candidates have used the same site to raise money. And they are joining a host of businesses, organisations and individuals across the world who have, over the past two decades, turned to the crowd for cash.
Crowdfunding is widely defined as a (usually large) group of people donating, lending or investing towards a cause via the internet. While it’s quite likely that you haven’t participated in a crowdfunding campaign, you may well know someone who has. According to the UK-based real-time data website The Crowdfunding Centre, there are currently over 22,000 active projects crowdfunding worldwide, with an average of around 450 new projects each day.
In the US, using a web-based platform to raise money from lots of people started to gain traction in the early 2000s. According to WordSpy.com, the word “crowdfunding” was first used in August 2006, by Michael Sullivan, who launched Fundavlog, a failed attempt at a videoblog content incubator. Here in the UK, prominence came just a few years ago, with major players CrowdBnk and CrowdCube launching in 2011, and Seedrs in 2012. Ayan Mitra, founder and chief executive of CrowdBnk, pinpoints the turning point to 2012, when former Legal & General boss Tim Breedon published the Breedon Report, arguing that the government desperately needed to boost alternative sources of capital to plug the funding gap faced by small businesses. He estimated that the gap would be around £59bn by 2016, with the report suggesting that retail investors needed simpler ways to fund SMEs.
Crowdfunding as we know it might be a novel response to a recent problem, but the idea of turning to the masses to get a project off the ground isn’t new. With echoes of the cooperative movement of the nineteenth and twentieth centuries, and the seventeenth century system of praenumeration – where collective fundraising was used to finance planned but not yet printed publications – online crowdfunding platforms are a modern iteration of an age-old human circumstance: if single individuals or institutions won’t fully back you, turn to the market. A good pub quiz fact is that money from “the crowd” was used to fund the base of the Statue of Liberty.
As even these early examples show, crowdfunding intensifies people’s desire to invest in projects where they can see potential value for themselves and/or for others. The UK’s largest ever equity-based round to date was achieved by Chapel Down winery, which raised £4m last September from 1,400 investors. Speaking to City A.M., chief executive Frazer Thompson said: “We believe that our crowdfund investors add extra value you just couldn’t get from a bank. Like us, they have passion, and they believe in the business.” Investors become mouthpieces for the businesses they support, carrying both a financial and emotional stake.
The fan-like excitement crowdfunding can harness saw the earliest campaigns focus on music and entertainment. In the first ever internet-based crowdfund back in 1997, fans of British rock band Marillion underwrote an entire US tour, raising $60,000 – and it was the fans, rather than the band, that initiated the fundraise.
Now, crowdfunding projects range widely from gadget rollouts to eco-technology ventures, from local community projects to startups and small businesses looking to scale. But even so, Kickstarter, the largest platform for creative projects in the world, still finds that video and tabletop games account for more than $2 of every $10 spent on it.
At the end of January of this year, the highest crowdfunded project ever was recorded: Star Citizen, a (not yet built) US online space trading and combat video game, which has raised an astonishing $75m, proving the crowdfunding power of connecting a niche product direct to its market. People know what they want, and will even fund its creation.
Yet crowdfunding’s rising prominence – and its extension into areas where investors really do expect more than the chance to back a project they care about – also means growing questions over risk. Even if projects are fully funded, there is no guarantee that promises to investors will ever be fulfilled.
Many leading platforms run thorough assessments on investors, ensuring that they understand risk, or can prove that they meet certain government-defined standards for net worth or sophistication.
But with half of UK startups failing within five years, the Financial Conduct Authority regards the chance that investors will lose 100 per cent of their capital as high. Two recent US studies found that at least 70 per cent of projects miss their delivery deadlines.
Then there’s the problem of pivoting, where a business that has raised money through the crowd then changes its model. More often than not, investors who signed up for one plan then have no say over how their money is used. Investments are also highly illiquid, and it’s unlikely that there will be a secondary market for shares any time soon.
But this nascent industry – and those participating in it – are clear about the challenges it faces. When it comes to the issue of crowdfunded companies going under, Jeff Lynn, co-founder of Seedrs, says “we have already seen several of our early investee companies fail, and the discussions we have observed on our post-investment pages have been uniformly sober and supportive”. The two areas usually focused on, he says, are how to write off the loss for tax purposes and wishing the entrepreneur good luck in their next venture. Every day, he says, “we see how sensible, grown-up adults are fully capable of making their own risk assessments and investment decisions”.
Mitra echoes this: it’s not even business failure that poses the greatest risk to the industry, he says. “The biggest risk is when those who invested through a platform fail to get a return that’s in proportion to the risk that they took. This is because strong returns are predicated on fair valuations at point of investment.” The answer, he says, simply lies in investors being able to turn to platforms that ensure the fundamentals of a business, including the valuation, are sound from the outset.
And increasing numbers of dedicated and thorough platforms in the UK mean we’re starting to catch up with the US. According to a February 2015 study by EY and Cambridge University, the fastest-growing subsector of alternative finance in the UK in 2014 was equitybased crowdfunding, which grew by 420 per cent.
Now, in full knowledge of its limitations, crowdfunding is an industry that’s quickly – and successfully – growing up. And alongside the chance to get involved in some exciting projects, it also offers investors the opportunity to have a truly adult relationship with risk.
THE FOUR TYPES OF CROWDFUNDING
The earliest iteration of crowdfunding, individuals simply donate to a business, project or venture, with no promise of rewards or payback. While you will find pitches for donations across many platforms, some are dedicated solely to donation, like GoFundMe, Fundly and YouCaring.
Like a donation, but those funding the campaign get the promise of rewards, usually based on how much money they give. Rewards-based crowdfunding campaigns retain their intellectual property rights. That means that platforms like Kickstarter aren’t producers or marketers, but sophisticated middlemen.
Investors lend money to a business or individual, then receive their money back with interest. This is how peer-topeer lending works, but it’s also an option for crowdfunders, who will usually set an interest rate and loan term. Example platforms include Trillion Fund, BuzzBnk and Abundance Generation.
Investors put money towards a campaign in return for shares or a small stake in the business, project or venture. As with other types of shares, if the business is successful, the value should rise. And vice versa if not. CrowdBnk, Seedrs and CrowdCube are three of the best-known platforms in the UK.
Julia Groves is the chief executive of Trillion Fund, a crowdfunding platform that offers peer-to-peer loans and other investments in UK clean energy. She is also the chair of the UK Crowdfunding Association. She shares her favourite recent investment picks.
OAKAPPLE BERWICKSHIRE | TRILLION FUND
This project has been set up to own and manage solar PV systems which will be installed on domestic rooftops. The company is looking to raise up to £3.1m via 20-year loans, offering a rate of return of 7.5 per cent.
COMMUTER CLUB | SEEDRS
This innovative firm offers P2P credit for annual transport tickets – and has been selected for The Fintech50 2015. It’s overfunded, but is offering 18.03 per cent in equity, and has a valuation of £2.5m.
COMPARE AND SHARE | CROWDCUBE
The company provides a comparison marketplace in the sharing economy, helping consumers to access and exploit the world’s £3.5 trillion worth of spare goods, without having to trawl through 7,500 individual sites. It’s overfunded, but initially offered 6.25 per cent in equity for £50,000.
FRUIT FACTORY | BUZZBNK
This Sussex-based firm takes fruit that’s condemned to go to waste and, with a team of volunteers, turns it into juices, chutneys and jams. It currently processes up to five tonnes of fruit a year. It’s trying to raise £12,000.