Crowdfunding for Business Startups

At a time when banks and private investors are taking as few risks as possible with their lending, crowdfunding provides a very important platform for small businesses and startups to get off the ground and is gaining popularity every day with over 600 online crowdfunding platforms now operating around the globe.

The dramatic increase in startup funding coming from crowdfunding websites has been well documented. Research company Massolution estimates that in 2013 over US$5.1 billion was raised on crowdfunding websites across the globe, almost double the figure raised in 2012. This massive change is in part due to the lifting of the ban of ‘general solicitation’ in the US meaning that businesses and entrepreneurs can now publicly advertise that they are looking for investors.

With this rise of crowdfunding for business, pitching for startup funding has never been easier or more widespread. However, even as the popularity of these crowdfunding websites has grown, the percentage of businesses to reach their funding targets remains low, meaning that the majority of pitched business startups receive nothing. For two of the most popular sites among startup companies, CrowdCube and Seedrs, the percentage of unsuccessful pitches stands at 80%.

Despite the low success rate of crowdfunding for business, startups in need of investment should not be deterred. This difficulty demonstrates that crowdfunding is taken seriously at both ends and, with strict regulations set out by the Financial Conduct Authority (FCA), ensures the process is only viable to those with strong business skills in either venture capital (the lender) or entrepreneurship (the pitcher).

Why MBAs might consider crowdfunding for business

Whereas traditionally the prospect of gaining seed investment for a startup was rooted in your own affluence or who you knew, such as financially stable friends, family or business partners, the crowdfunding phenomenon has meant that business startups with a solid business plan and enough public support are able to gain startup funding from outsider investors around the globe in as little as 30 days.

For entrepreneurs fresh out of business school, or, indeed, those still at business school, crowdfunding is a particularly attractive route into entrepreneurship because there is no loss for unsuccessful pitches. At the very least, you will gain more knowledge about the type of interest your service or product can generate in the public and private market, helping you develop an improved pitch later on in your entrepreneurial career.

Upstart is one crowdfunding site that offers something different, appealing most likely to MBA and business school students. Its ‘retire student loans’ initiative sees graduates writing off their student loans by selling a small percentage of their future earnings to investors. The scheme states that its aim is for graduates to invest in themselves and their education. The well-reported rise in school’s fees around the globe makes this offer appealing to students and allows them to take risks within their education and career as backers invest in the person, not a certain project or industry career.

In 2013 Rachel Kim, an MBA from Harvard Business School and former Google employee, raised US$100,000 from 37 investors on Upstart. Half of the money she raised went towards paying off her student loans and the other half helped to launch her e-commerce beauty business Nailed Kit. This is an example of how MBA students can gain support without having to have a business plan or a career path mapped out in a specific industry (although, of course, clarity of vision and ambition does help when attracting investors).

What’s in it for startup investors?

It’s all very well then for Rachel Kim and others like her, but, the question is, how do investors benefit from crowdfunding for business?

The simple answer is that the investors believe that Kim and others like her have the potential to make serious money in business and they want to have some of when it comes along. In Kim’s case, investors will see 6% of her income over the next decade. The good thing for Kim however is that if her salary isn’t above US$30,000 on a single year, she is allowed to skip that year’s repayment and the contract gets extended one more year.

In other cases, instead of receiving monetary interest on their investment, investors will see a return once the company experiences success, as their investment will give them a number of the company’s shares or a similar stake. Often, if the business hits the big time, this can lead to huge returns.

The co-founder of Crowdcube, Luke Lang, said of the recent flurry of crowdfunding websites: “Crowdfunding is transforming equity finance by giving budding businesses an alternative way to attract investment, through showcasing the opportunity online and inspiring a new breed of angel [investor].”

A risky business for startup investors?

As with all venture capital, the risks for startup investors are significant. For the majority of these crowdfunding websites, investors are vetted and only allowed to invest when they have been deemed serious enough. Although many are cautious of a market where the risks are so high and there is no guarantee on seeing a return on their investment, often for seasoned investors the pros outweigh the cons. For example, since Upstart’s launch in November 2012, investors have seen US$2.1 million return on their money from just 160 entrepreneurs (50% of which have been entrepreneurs launching business startups).

On the other side of the coin, businesses pitching for funding are in a better position. All it takes is a solid business plan and some public support and you have a small chance of getting that all important seed money for your business venture.

From this is it clear that, although risky for startup investors, there are considerable profits to be made on all sides of the crowdfunding process.

From Kickstarter to Crowdcube for startup funding

For some crowdfunding websites, such as Kickstarter, the appeal for investors is that there is much less risk involved. The return that backers see with Kickstarter is with the fruition of the product itself along with early access to it. Dependant on how much money is pledged, funders may also receive the product for free or cheaper than retail price once developed.

For Kickstarter no business plan is too small and no investment is too little. The idea that anyone in the world can back your business idea is an incredibly powerful one and has given the site overwhelming popularity with the public, as well as independent artists and new businesses.

While Crowdcube works differently and has a more exclusive focus on raising startup funding for newly operational businesses looking to expand, the Kickstarter model appeals more broadly to the general public rather than serious startup investors. This shouldn’t deter those looking at crowdfunding for business purposes however because public support can be very powerful. The public, although often pledging small amounts, provide support in their masses to ideas they believe in and want to see come to fruition. The incentive for the general public is not a return on investment but rather a first look at the finished product and being able to support businesses and products that they believe in. Consumer loyalty is also something to consider as, if your product or project does raise enough money, your many supporters may well become returning customers.

Crowdfunding websites

CrowdCube – Crowdcube is one of the longest established crowdfunding websites, providing businesses in the UK with the opportunity to pitch for funding. The majority of these businesses are already operational and looking for investment in order to expand in their market. Approximately 420 businesses are hosted on the site with over UK£15.3 million (US$25.5 million) from investors raised so far.

Fundable – Fundable, launched in 2012, is a US-based platform that hosts reward- and equity-based campaigns for small businesses.

FundingCircle – Based in the UK, FundingCircle is a place for private lenders to invest a lump sum in a business for a good rate of interest. Although crowdsourced, FundingCircle is for small businesses looking for competitive loans.

InvestingZone – Launched in May 2013, InvestingZone is an even newer site giving investors access to businesses in early development in the UK. Investors must pass a test on the crowdfunding market to prove they are serious in investing and knowledgeable of the risks. So far the site has funded nine out of nine businesses and raised a total of UK£966,000 (US$1.61 million).

Kickstarter – Perhaps the most popular of the lot, Kickstarter was launched in 2009 and helps independent projects get off the ground thanks to public support. Pledgers receive their reward in the form of product merchandise and often the product itself once it has been produced.

MoolaHoop – MoolaHoop, based in the US, is more niche than most crowdfunding websites and provides a platform exclusively for female entrepreneurs and their business ventures. The site is rewards based and helps small businesses gain investment and future customers.

Seedrs – Seedrs is a European based site with a focus on providing startup entrepreneurs with initial seed money from business investors. Investors can give as little as UK£10 (US$16) in exchange for equity in the company once it takes off. The site lists 300 new startups and has raised UK£2.3 million (US3.8 million) so far.

SyndicateRoom – SyndicateRoom is a UK-based crowdfunding model seeking ‘top up’ investors (funding at least 25% of the total investment) for ventures which have already received seed investment in the past. Of the seven businesses to have been listed on the site, all have reached their targets and between them have raised UK£950,000 (US$1.58 million) in total.

Upstart – Founded by ex-Googlers in 2012, Upstart is the first crowdfunding platform allowing people to invest in a person and their earning potential.