On 22 February 2017, an engineer who worked for Garmin, who happened to be Indian, was shot and killed in a hate crime. A bystander who intervened was severely injured. The public response was immediate and overwhelming. A crowdfunding project was set up for the engineer’s widow and children, and within 7 days 18 000 people had contributed nearly $700 000. A similar project was set up for the hospitalised victim, the $450 000 will cover his hospital bills. The majority of people who contributed were strangers from all around the world who contributed as little as $5 to express their outrage and condolences. This is the power of crowdfunding.
The new sharing (and caring) economy
Traditionally, when you needed a loan for your bright idea, you approached your bank manager, cap in hand, asking for an advance or a loan. Your chances of success were low. You had better luck borrowing from friends and family, especially if they had helped before and seen some benefit from the loan, or at least got their money back. Then along came the Internet and the rise of social media. Suddenly there was very cheap access to millions of people who could be encouraged to invest, loan or donate to a project or cause that interested or excited them. Initially, money was raised for musicians, artists and their events, leading to Artistshare being incorporated in 2001. The rise of other crowdfunding platforms only really took off less than ten years ago, with names like Indiegogo and Kickstarter appearing on the scene in 2008 and 2009. Since then, hundreds of other crowdfunding platforms have been developed, raising money for a variety of reasons.
Crowdfunding offers the funder different rewards based on different funding models and differing funding needs. A few years ago, it was commonly held that there were four models, but the variations are growing. Here are the major models:-
– Donation-based. This is philanthropic funding of a cause, with no expectation of reward, such as donating mosquito nets to malaria-prone regions.
– Reward-based. In return for your investment you receive a product or service in return, such as the innovative product you are funding, or in the case of sports funding, a t-shirt or cap with the team or person’s name on it, or even a meeting or dinner with the sportsperson. The rewards are usually based on the amount sponsored. This form of funding is used for start-ups and individuals.
– Peer-to-peer-based. This is more commonly used for business borrowings, and could be likened to a rights or capitalisation issue in the stock market. The borrowers are established businesses that wish to expand and the investors will receive returns. These returns can take the form of one or all of the 3 options listed below. This is often a B2B initiative, although funding could be coming from an angel investor.
– Lending Based. You receive an annuity repayment, or an interest or dividend payment based on your initial investment, in the traditional manner of equities, bonds and debentures.
– Equity-Based. You receive a shareholding in the venture, which will bring you rewards if the venture prospers.
Related to the last is royalty-based crowdfunding, where you receive a share of royalty income, based on the intellectual property of the product, such as a mobile app or game.
Applying crowdfunding in retail
As crowdfunding evolves, more models emerge. One of the more interesting variants of reward-based crowdfunding was started by online retailer Teespring, which now has several imitators, including Amazon’s Merch. Teespring is a platform where anyone can become a member and design a t-shirt (or other consumable). They must then promote it via a Facebook Ad or similar marketing aid. Prospective buyers order one or more units on the Teespring site and, when a preset quantity has been ordered, production can start. Teespring prints and despatches the t-shirts to the buyers, taking a flat manufacturing fee, plus shipping costs, and the seller receives the profit on the item. There is no risk to the buyer, the seller or Teespring. If the crowdfunding quantity is not reached, the seller can either reduce the quantity, extend the length of the campaign, advertise more or cancel the project, in which case prospective buyers are refunded.
Let the buyer beware
Crowdfunding has seen some huge successes and failures during its brief decade. It is important to remember that this is venture capital for the man in the street. Some of the campaigns can result in profit, or, if you are lucky, a working product. Some, despite the platforms’ best efforts to weed them out, are nothing but scams. It is useful to look at some of the largest campaigns to get an idea of the success and failure rate.
Even Mark Shuttleworth does not always get it right
Who would not back a campaign with the trusted name of Ubuntu behind it? The Ubuntu Edge was a stunning concept phone that did have huge and immediate response for what promised to be a great product. Unfortunately, although over $12 million was raised via Indiegogo in less than a month, the required funding of $32 million was not achieved. Disappointed funders were gracefully refunded. This is not the end of the story however: the Ubuntu Phone and other devices are still around.
The Rise and Fall of Pebble
The Pebble smart watch was one of the most successful Kickstarter campaigns ever and was followed by two successive campaigns for new generations of the watch. Over one million watches were sold by the end of 2014, but the company eventually closed at end December 2016, due to financial constraints. The failure rate of startups is high, even when there was such initial success. Two factors that contributed to Pebble’s closing were the competition of Apple with its Apple watch and the slower than expected growth in the wearables market. Wearables company Fitbit acquired Pebble’s IP and some of its employees.
A Hard Fork in the road: the DAO debacle
Blockchain technology promises to be one of the most disruptive forces in financial markets in this century. Keen investors recognise this and have thrown lots of money at blockchain campaigns. The biggest crowdfunding campaign was for the DAO, the “decentralised autonomous organization”, a stateless virtual entity that gives one a headache just trying to understand it. Despite the headaches, the campaign for the DAO raised $150 million. The DAO operated on the Ethereum platform, and in June 2016, hackers broke in and made off with a third of the funds in the DAO. In order to restore the funds, Ethereum instituted a “Hard fork“, a mechanism that creates a new blockchain to which participants in the old blockchain must gradually migrate, as the old chain is no longer valid. The participants in the blockchain vote for or against a fork, and by creating the hard fork, Ethereum restored funds to those affected by the hack.
Blockchain is good for crowdfunding too
Blockchain has also become the new platform for crowdfunding. One of the disadvantages in funding via conventional sites such as Kickstarter is that they take a good cut of funds collected as intermediaries in the process. Contrast this with CCEDK’s OpenLedger, a blockchain platform where the entrepreneur can launch and start trading before being fully funded, using crypto-currency. This could be the future of crowdfunding. It gives true freedom to the entrepreneur to solicit funds without interference.
Regulating the sharing economy
Crowdfunding will definitely have a disruptive effect on traditional lending in the next few years. While banks and venture capitalists are mainly involved in macro-loans, the micro-loans that crowdfunding support create new small businesses and erode this market for banks and credit granters. The potential of crowdfunding has been recognised by governments, which are gradually introducing new, less restrictive legislature that enables lending by individuals to start-ups, via removing of restrictions where necessary and tax reductions and incentives.
In 2012, the US government tabled the JOBS (Jumpstart Our Business Startups) Act. Section III of this act specifically addresses crowdfunding, and the platforms that support it. The intention is that the crowdfunding platforms will provide much of the regulation required, taking the burden off the State and ensuring the minimum of doubtful projects.
Europe has been a bit slower to react. Great Britain recently recognised a tax exemption for sharing economy income up to €2500. Recently Belgium has entered into the fray, with the recognition of the “sharing economy”, by reducing the tax on services which are in this scope and do not exceed €5000 in income to a tax of 10%, down from 33%. Just as in the US, much of the regulation is laid at the door of the crowdfunding platforms. What is interesting in Belgium’s case is that this comes from the Ministry of Digital Agenda and Telecom, and not Employment, Economy and Consumer Affairs.
What the future holds
Despite the cautionary tales above and many more that we did not highlight, crowdfunding is here to stay, although the blockchain models could disrupt the current industry. All predictions for crowdfunding are positive. It was estimated that crowdfunding would exceed venture capital funding for the first time during 2016. Although the results are not in yet, research from the World Bank estimates the global investment in crowdfunding by 2020 will exceed $90 billion. Most of the growth will occur in the developing world. China has become a strong adopter of crowdfunding. This probably relates to the change in the economy from manufacture-based to service-based and the rise of small entrepreneurs. What is harder to predict is what the impact will be on the traditional lenders – they will probably need to build or buy their own crowdfunding platforms if they want to stay relevant to small borrowers. They should also be looking at a blockchain model for sustainability.