In the past, if going to the bank was not an option, the best way to raise cash was to pass round a hat to friends and family. Technology has changed that. Social networking sites have led to many individuals with a compelling idea or passion amassing sizeable funds from thousands of strangers each chipping in pocket change. This kind of ‘crowd funding’ received much publicity last year when the controversial whistle-blowing site Wikileaks called for financial aid from its millions of supporters worldwide to set up a legal defence fund. When Paypal and Mastercard blocked payments to the fund, those supporters registered their outrage – and their determination to protect crowd funding – by launching a cyber attack on PayPal and MasterCard’s websites.
Most crowd funding is less fraught. The charity Cool Earth was formed after Frank Field, a British member of parliament, read about Johan Eliasch, the wealthy chief executive of Austrian sporting goods firm Head, buying up chunks of rainforest to protect them from loggers. “Most of us don’t have your resources but imagine what millions of us could achieve together,“ Field wrote to Eliasch in 2008. By the end of last year, they had tapped 140,000 members around the world, who together have saved 46 million trees.
By then a huge number of crowd- funding start-ups had sprouted up, each jostling for a piece of what had become a lively market. These include Kickstarter in the US, FundBreak in Australia, Startnext.de in Germany and My Major Company in France – though there are many, many more. Projects funded include documentary films, software development, microgeneration, schools in Africa, fashion and music.
In the past, for legal reasons, crowd funding has typically involved soliciting donations in return for some kind of membership or pre-purchase of products. In effect, they’ve been subscriptions. What they’ve tended not to offer are financial rewards – because it’s illegal to solicit investments from the general public unless the opportunity has been filed with an appropriate securities regulator.
Ecotricity, a green-energy firm based in Stroud, England, took care to comply with regulators when it sought funding through a type of crowd funding last year. Ecotricity wanted to build wind turbines for which it had planning permission; and the sole shareholder, Dale Vince, a former hippie, wished to avoid diluting his ownership but steer clear of banks. So he offered to sell £10m (€12m) in low- denomination bonds to the public, with a higher rate of interest payable to his own customers. The bonds raised £14.3m (€17m) – the largest ever private issue in the UK, the company claims.
Dale Vince. Photo: Treehugger
Ecotricity’s bond issue was substantially over-subscribed because it offered a valuable investment: 7% interest, or 7.5% to Ecotricity customers, is a lot more than you get on most savings accounts. Ecotricity decided to prioritise customers, who received 100% of what they subscribed for – in other words, it paid out more in interest than it might have done, because it recognised the value of customers’ support. It’s for that reason that Ecotricity’s bond issue should be regarded as crowd funding, rather than a conventional sale of high-value bonds to a small handful of financial institutions.
That particular bond issue was regulated, but smaller fundraisings, along very similar lines, often take place without such oversight. A well-known example involves a New England restaurant owner named Frank Tortoriello who was looking to move to a nearby location but couldn’t get a bank loan. He sold food vouchers worth $10 to customers for $8 – in effect, discount vouchers worth 20% off– and in 30 days he raised thousands in hard cash. Tortoriello’s example has been followed by countless advocates and promoters of local or complementary currencies.
Inevitably such inventiveness has soared online. The 2009 climate-change film The Age Of Stupid, for example, was funded by pre-selling a percentage of [hoped-for] profits to 258 individuals and syndicates while 400 others donated to the £450,000 production budget. “When we first came up with the idea and put it on our website,” says the film’s director, Franny Armstrong, “our lawyer said: ‘It’s the most innovative film-financing scheme I’ve seen in 25 years. But it’s totally illegal.’” Armstrong made the changes her lawyer suggested and got the plan approved by the Financial Services Authority to give investors confidence.
Today, bagging funds for cherished projects no longer depends on serendipitous visits to someone’s Facebook page. The best-known of the new online ventures encouraging crowd funding is Kickstarter, which is based in Manhattan’s hip Lower East Side and whose model is similar to that used by the in-vogue group-purchasing sites. To raise funds, creators of each project must set a cash goal and a time limit, though there’s no limit on the amount that can be raised. If enough ‘buyers’ pledge funds, the project keeps them. If they don’t, they are returned. Kickstarter takes a 5% fee on all successfully funded projects.
Typically, individuals or organisations seeking funds offer a range of rewards. A band might give away a T-shirt to small donors and dinner with its lead singer to people with the deepest pockets. Kickstarter works with the project sponsors to establish specific price points at which rewards are offered.
Some donors argue that making a very small payment is effectively a gift, because usually the rewards are not hugely desirable. At a higher level, backers are in effect buying the reward – they really want dinner with the rock star. Publisher and writer Craig Mod, who used the crowd-funding model to republish a book, says: “People don’t mind paying $50 or more for a project they love.”
Kickstarter’s chief community officer, Yancey Strickler, says that in general the firm accepts around half the projects it receives, weeding out begging letters and straight business expenses. Roughly half of those realise their funding ambitions: around 1,600 projects had been funded by July 2010.
Buzzbank, a British version of Kickstarter launched late last year by the serial social entrepreneur Michael Norton, has already attracted more than 34 ventures. It brokers investments in social enterprise projects, enabling donors to participate in the upside of a new company’s growth. Rather than making a one-off donation, investors have the option to take dividends or recoup once the social enterprise moves into profit. Investors can browse through the Buzzbank ventures and pledge money and/or time while carrying the message through to their own social networks and communities.
This new market is nourishing an ecosystem of intermediaries, each with a slightly different model. ChipIn, for example, started in 2005 as an online fundraising service but has become a “web payment simplification app” that’s free to use for other companies. GoFundMe charges 5% on each transaction, on top of PayPal fees.
RocketHub takes money upfront rather than just a pledge: if the donor’s preferred project fails, the money isn’t returned but must be allocated to another project instead. Give.fm enables donors to make recurring payments, providing financial stability to causes they support. “And with a monthly pledge that can be cancelled any time, you’re holding the cause accountable,” says a spokesman.
PeerBackers co-founder Sally Outlaw says most businesses already know their backers. “Probably 80%-90% are from their own network who learn about them through networking and the media.” People opt to list on PeerBackers and similar sites that take a cut, she says, simply because it removes the need to ask people they know in person for money.
However not all social networks are online and not all entrepreneurs are so shy. Armstrong promoted the idea of The Age of Stupid at an event held by The Funding Network – a club that runs ‘auctions’ where individuals bid to back a wide range of projects.
Promoters looking for cash make short pitches and there’s a Q&A afterwards.It’s not unusual for projects to receive as much as £10,000 (€12,000) in a night, sometimes much more. The founder, Fred Mulder, set up the network after bad experiences as a donor. He says: “I realised that I’d be in a much better position if I had a group I could check with. With our events you hear a presentation and talk to other donors. You compare and contrast.” One person at the Funding Network event who contributed to Armstrong’s film was Michael Norton, who went on to set up Buzzbank. “We felt proud to have helped create an award-winning film – but the surprise was when payments from the profits appeared in my bank account.” Will crowd funding become part of the investment mainstream?
One could argue that it already sustains much present-day enterprise. This becomes clear when you consider the surge in ‘pre-pack’ insolvencies during the economic downturn – in which the owners of companies wipe out their debts and start again. Everyone knows that equity is meant to be more risky than debt, but in present economic circumstances, the owners of failed firms often continue to own the business while suppliers – landlords, stationers and suppliers of other goods – find themselves unpaid. In effect, their trade finance has been used as a form of working capital – and those suppliers have functioned as solid, if unwitting, crowd funders.
First published in CNBC Business magazine