Crowdfunding: your next source of capital?
Can a small business really look to crowdfunding as a viable method of raising growth capital? Growing Business investigates
With Project Merlin still very much a work in progress, sourcing growth or start-up capital remains hugely challenging. So why not follow the example of the creative industries and harness the power of the crowd?
Over the last few years an increasing number of authors, musicians, artists and filmmakers have raising money for their projects via online ‘crowdsourcing communities’. The concept is simple. Let’s say a film producer needs £20,000 to complete a project. By going to a crowdsourcing site, he or she can pitch the idea to tens of thousands of potential backers. And here’s the good bit. Because the numbers of people involved are relatively large, our enterprising filmmaker can raise the cash from hundreds of small pledges rather than a concentrated group of major investors. It’s the power of the crowd.
Until relatively recently, crowdsource funding has been limited its scope. If you can make it work for you, it’s a great way to raise funds, but US sites such as Kickstarter and Kiva have tended to focus on the creative arts, quirky businesses or social ventures. As such, crowdsourcing wasn’t seen as a source of capital for mainstream companies.
But that’s changing. There are still plenty of sites – many of them US-based – where you can pledge a few pounds in return for a mention on an album sleeve or an invite to an exhibition opening night, but there is also an increasing number of platforms that offer investors the prospect of a real return on their cash while giving businesses an opportunity to raise serious sums of money.
Debt or equity?
Crowdcube is a case in point. Based in the UK, the company’s online platform provides a means for businesses to pitch ideas to a community of equity investors. On the face of it, Crowdcube is offering a variation on the angel network theme, but there are at least two significant differences. Firstly, unlike many angel networks, there are no upfront fees. Businesses can put their case to investors free of charge and payment is only required once a deal is closed. Perhaps more crucially, the site remains true to the original crowdfunding concept. As founder Darren Westlake explains, the site is open to non-professional investors who may only be prepared to invest small sums. The idea is that if a business needs, say, £75,000, that money can be raised from combination of small and large sums from the site’s 2,500 registered members. “If someone can’t invest £50,000 they can invest £50,” says Westlake.
The upside of this arrangement is that businesses can tap into the resources of a large group of business-friendly investors. And the potential downside? Well, in order to turn the pledges of Crowdcube investors into hard cash, businesses have to secure commitments for all of the money originally asked for. Nothing strange about that, but almost by definition, raising £75,000 or £100,000 in relatively small packages is going to be a long haul. Having launched earlier this year, Crowdcube is still waiting for the first deal to complete, but that landmark is getting close.
As things stand, the flagship company is Bubble and Balm. Founded by Sue Acton, the company specialises in supplying body care products that comply with the criteria set down by the fair trade movement. The company has already made inroads into the retail marketplace, with contracts to supply Waitrose, Oxfam and distributor Planet Organic. Latterly sales have been increased by the company’s inclusion in a Waitrose 3 for 2 promotion.
Boosted by this success, Acton is confident that she will be able to raise the £75,000 she needs from the Crowdcube community. “We have secured pledges for 45% of the money so far and that’s about to go to 50%,” she says. “We’re expecting the investment to close in the next four weeks.”
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The Bubble and Balm campaign began at the beginning of the year and has steadily picked up support from investors. As she noses past the half way mark, Acton believes she has achieved the critical mass of support that will see her across the finishing line. “What we saw was an initial rush of ‘early adopters’ and then it went quiet for a while,” she says. “Now it’s picking up again. I think a lot of people want to see you passing a tipping point before they pledge to invest.”
In the meantime, Sue believes the experience of pitching on Crowdcube has already helped the company. “As things stand I have about 40 investors,” she says. “They have contacts and they have been promoting Crowdcube.”
Crowdcube is by no means the only game in town when it comes to crowdsourced equity investment. Launched earlier this year, Northern Ireland-based Seedups has big plans for a venture that sits somewhere between traditional crowdfunding and the better-established world of angel networks. In contrast to Crowdcube, Seedups aims to attract sophisticated investors and high net worth individuals rather than a broader community. “We didn’t go 100% down the crowdfunding route,” says founder Michael Faulkner.
Regulatory issues played a part in determining the company’s strategy. “There were just too many regulatory pressures associated with non-sophisticated investors,” adds Faulkner. “In addition to the UK market we wanted to take the company to the US and over there most of the rules imposed by the SEC (Securities and Exchange Commission) are there to protect the non-sophisticated investor group.”
Red tape wasn’t the only factor, though. As the company name suggests, Seedups’ sweet spot is the provision of seed capital for companies that have yet to gain any traction in the marketplace and in Faulkner’s view, high net worth individuals are better placed than small investors to assess the risks deliver the sums required. “Our model is fundraising events of between £50,000 and £250,000,” he adds. “We see high net worth individuals are providing the most appropriate liquidity pool.”
Nevertheless, Faulkner asserts that Seedups is not simply an angel network by any other name. “The thing that differentiates is us is the ‘legals’,” he says. “For investors and companies we have documents that make it easier to standardise the whole process.” This makes the paperwork and due diligence associated with raising finance and investing cheaper. And as with Crowdcube, companies seeking to raise cash pay a fee – in this case 2% – only when the deal closes.
As with Crowdcube, it’s early days. Having launched earlier this year, Seedups is still waiting to close its first deal. “We are near to completion with a couple of companies,” says Faulkner.
The debt alternative
If selling equity doesn’t appeal, debt finance is also available through the crowdfunding model. For instance, British-based Funding Circle has to date advanced 210 loans to businesses on the basis of an 8.4% interest rate. The average individual investment is £3,500 and the sums advanced range from £5,000 to £75,000.
The idea is that the lender spreads their risk by advancing cash to a lot of companies. The businesses themselves benefit from lower interest rates. While some investors choose which companies to support, others put their cash into a collective pot for distribution to applicant companies. As founder James Meetings stresses, the crucial factor is that Funding Circle underwrites the loans – essentially carrying out due diligence on the behalf of investors . “The marketplace needs to be a safe place and the fact that we do all the underwriting is essential to the success of Funding Circle,” says Meekings. In addition Funding Circle also handles the repayments process.
All of these businesses offer more than a simple dating service. Member forums provide a means for investors and businesses to communicate. Investors can talk to each other about the merits of the businesses pitching for cash – thus tapping into the wisdom of the crowd – while companies can keep the investor community up to speed. For instance, Sue Acton regularly updates the Crowdcube community on the latest developments at Bubble and Balm. “When something exciting happens, such as the Waitrose 3 for 2 promotion, I think it does improve our prospects for raising cash,” she says.
And there’s some sophisticated customer service. Funding Circle operates a secondary market in which lenders can cash in by selling the debt to others. Crowdcube is working on a similar service to allow equity holders to sell their shares. Meanwhile, Seedups provides a valuation service aimed at helping start-ups arrive at a price/equity figure that will be acceptable to all parties.
Depending on how the market develops, crowdfunding certainly has the potential to provide a useful of source of finance and in time it may become mainstream. Raising funding through equity investment may take time, but with growth and start-up finance in short supply elsewhere, crowdsource funding might just be worth a try.