While start-ups conceived in the garage or kitchen may have no shortage of good ideas they definitely – and usually – lack for small investors. But the emergence and success of crowdfunding has widened the pool of potential investors immensely. Raising small donations on the Internet does work, and start up hopefuls who have always wondered just how they can use crowdsourcing will learn how to do it in this article.
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
— Polonius, in Hamlet
If Polonius were around these days, he wouldn’t be getting much sleep. Particularly if you think of crowdfunding as borrowing from folks you’ve “friended.” Hundreds of thousands of loans have been made through crowdfunding. That’s hundreds of thousands of friends. Or ex-friends, as the case may be. In the U.S., with the rollout of the JOBS Act, wherein the need to register certain securities including fundraisings of less than $1 million is no longer necessary, and with similar legislation being considered in Canada, we’ll only see more of this kind of borrowing.
While the Internet takes the lion’s share of the credit for enabling crowdfunding, there’s a countervailing trend driving its growth. Bank lending for the types of entrepreneurial activities that crowdfunding is helping to finance has virtually dried up. Post-crash, the pendulum swing has found banks erring on the side of hypercaution, and crowdfunding is fast becoming the new disruptor in the world of finance. If startups are disruptors of established businesses, that makes crowdfunding the disruptor’s disruptor. Direct finance relationships are taking the place of traditional sources of borrowing – ultimately a side effect of the trend could be the death of a once profitable category of bank lending.
The definition of crowdfunding includes, these days, the use of web-based outreach and interaction, such as Facebook or other social media to raise funds. While all crowdfunding models involve the reaching of a capital goal through small contributions from many people, there are two basic approaches. Doing it yourself, or having it done for you by the crowdfunding equivalent of an investment bank. More on that, later.
The concept of funding a project by convincing a large number of people to contribute a small amount isn’t new. However, the Internet has taken the prospect up to new heights as well as down to the grassroots level. Now it’s possible for virtually anyone with a business idea, project, or cause to be crowdfunded, or to engage in crowdsourcing (an umbrella term for any “online, distributed problem-solving and production model”) – that is, anyone willing to think broadly about the use of social media or other online means to reach a large, and largely unscreened audience.
The idea is that there are a lot of bright, creative people – and investors who would support interesting new ideas – out there looking to be a part of something. And if you can figure out how to reach these people, it could be the answer to how you can get your business off the ground.
Many hands make light work. And for a tech-savvy entrepreneur looking to start up a business, get some help on a project that’s too big for a few people to handle, or merely bat around some ideas, crowdfunding can be just the ticket to lift some of the burden. Crowdfunding has been getting more media attention lately, bringing it out of the realm of word-of-mouth projects you hear about – like your former babysitter using it to start her own modern dance company. Now we’re talking about real companies sourcing millions, one contribution at a time. This approach helps support out-of-the-box ideas and thinking, particularly those that might not meet the underwriting standards of conventional financiers. Instead, they are making their appeal to the “wisdom of the crowd.”
How Crowdfunding works: It starts with crowdsourcing
Have you ever thought where would we be without Wikipedia? If there was ever a widespread example of the collective thinking power of the many, Wikipedia is that example. And yet this crowdsourced online resource, phenomenal as it may seem to anyone old enough to remember when it didn’t exist, is a familiar concept made modern by the channels through which it is conducted. The concept goes much further back. The Oxford English Dictionary, begun in the late 19th century, was a 70-year crowdsourcing project that is still receiving submissions (the term ‘crowdsourcing’ was added to the OED recently, along with the verb ‘tweet’). Six million entries have been sent in by post. That’s a pretty hefty crowd sample.
Making the leap to crowdfunding, you might think that it’s easy to get people to contribute their knowledge or creative ideas. But why would they contribute money? One of the short answers is that if the entrepreneur brings the right knowledge and creative ideas to the table and presents them in the right way, there are likely people who will want to jump on the bandwagon and get that project off the ground. At the very least, it would be the equivalent of “angel” level investment that’s looking more to support a deserving startup or project than to make a killing, which is more in the realm of venture capital money.
Moreover, there’s a school of thinking that says that if the idea can attract a large crowd of financial supporters, it is likely to have merit. Think about that for a second. In a sort of mind-bending way that’s the time-and-space inversion of Peter Lynch’s investment wisdom, or of the idea that you only value what you pay for. He often discovered some of his best-performing investments at the mall, by looking at what people were purchasing and taking home. If you like the store, chances are you’ll love the stock. In this case, if people like the idea enough to invest in it, chances are they’d go out and buy the product or service.
Open calls, selective calls
The entertainment world uses the term ‘open call’ to describe the process of bringing in a large pool of talent to audition for a production. Anyone who has ever hoped to act or sing has probably wound up at one of these casting calls, also called cattle calls. Not so long ago, these open calls would be advertised in the newspaper, or on bulletin boards in industry hangouts. Now they arrive in your email inbox as well as online. A more selective method of finding the right talent involves middle men, in this case agents. A producer or casting director might let several agents know what they’re looking for – or if it’s a part that they envision a certain actor playing, they might only contact one agent. That way the pool is smaller and pre-selected.
There’s a similar spectrum of scouting in business financing, though until now it’s been heavily weighted toward the selective end. If a startup needed funding, traditionally the entrepreneur would either parlay some of his own savings from the high-paying, expertise-enriching job he left; or he might ask some wealthy friends or others in his industry to invest; or he might connect with a PR firm to cast the net a little wider. Traditionally the entrepreneur would spend a huge amount of time on the road, visiting would-be funders. Crowdfunding has taken the bite out of that and added another level of possibility by opening up the appeal to anyone with a smartphone or laptop.
Several new players are entering the scene and are facilitating crowdfunding. They are the aforementioned crowdfunding equivalent of the investment bank. Startups themselves, their role is to seek out angel funding, thus eliminating the need for more traditional funding.. They have the potential to pose serious risks to traditional lenders.
Recently, a company called SeedInvest, an online platform designed to make it easier for investors to identify their ideal startups, was launched. In short, they are making it possible to do online what has been done in person for a century or more. Due diligence, compliance and the funding process itself are all seamlessly completed online, so that investing in a startup is as simple as buying a stock through your online broker.
CircleUp is another such platform. Launched in April 2012, it has become one of the largest crowdfunding sites, screening startup businesses, providing financials and other essential company information, and enabling investors to ask questions of the innovative CEOs heading up companies offered on the site.
Premium men’s apparel designer Gustin recently had a crowdfunded barn raising that netted $450,000 from more than 4,000 backers. Its creative approach to solving a longtime problem in the fashion industry – namely, producing clothing on speculation and then not being able to sell it or make a margin on it – has turned the entire equation of clothing manufacturing around. First, Gustin crowdsourced customer opinion on the styles, cut and fabric of the high-end jeans it makes. Then it made the radical move of going completely online and direct to the consumer, cutting out its ready-to-wear and brick-and-mortar operations. Much of the funding came from payment for pre-orders, which allowed the company to not only cut down on materials inventory, but gain much better intelligence on which fabrics and how much of them to order to begin with. Gustin found that its crowdsourced customers were willing to give up expediency – they now must wait four to six weeks to get the jeans they’ve ordered – in exchange for having a say in the design and manufacturing (sourcing) processes. Many voices make for good business – in this case, at least.
Another innovator who’s been receiving good press recently is 22-year-old Lucas Duplan, the tech wonder boy who finished an undergraduate degree in computer science at Stanford in three years. Duplan started Clinkle, a payments platform that aims to replace credit cards with smartphones, with $25 million in early financing acquired by… crowdfunding. His early investors include Accel Partners, Andreesen Horowitz, Intel, Intuit, Marc Benioff of Salesforce.com, and Peter Thiel of PayPal. Granted, he had some heavyweights pulling for him – including one of the first investors in Facebook – and spreading the word, but between his geographic location in Silicon Valley, his innovative high-tech idea, and the mystery with which he’s surrounding his methods, Duplan and Clinkle have the perfect ingredients for a wildly successful startup.
Who should use crowdfunding?
This brings us to the question of who should go this route and why? Should crowdfunding be a last resort for a startup, or a grand, democratic opening gesture? The most successful crowdfunding examples have a certain spirit behind them: first, a personality that’s not afraid to take the heat, nor afraid of interacting with people and confidently telling his or her story. If you’re a technophobe, or resistant to new ways, crowdfunding probably isn’t for you. It requires a lot of energy of a very specific kind, and involves a lot of up-to-the-minute, out-of-the-box thinking. It might involve improvising, or at the minimum thinking creatively about how things can be done, and for how much (or little) money. It’s geared toward the attention span of the generation that demanded fast-frame action films. Don’t blink or you’ll miss it.
In a sense, crowdfunding is a modern-day version of the wild west. It’s a land grab, a democratic, open virtual process that can result in a payout. But even with the best of intentions on the part of the funded, and due diligence on the part of the funder, it can result in a loss. Odds are strong that an investor in a crowdfunded project is unlikely to get a quick return on the money put in. To be attractive to the investor, the entrepreneur has to appear with the big guns of idea, business drive, personality, reasonable incentives, good connections, and great PR execution. In turn, the would-be funder has to come in ready to do some homework and wield a healthy dose of skepticism.
For the entrepreneur, crowdfunding sites like Fundable.com and Kickstarter coach their startup clients to think through the process, but only to a certain degree: have a story on which to hinge your campaign; provide reciprocal value; create scarcity by limiting the number of rewards you offer; build credibility; stay in touch with your supporters. From there it’s up to you, your contacts, and your sheer ingenuity.
What’s new soon becomes mainstream
It’s not surprising that crowdfunding – a business approach that only a short while ago seemed radical – found its beginnings among artists, creatives, and innovators. Though a few large institutions have hosted crowdsourcing events – such as IBM’s 2006 Innovation Jam, Swift’s Innotribe regional forums and Procter & Gamble’s Incubator Day featuring CircleUp clients – on the whole this Internet-based form is geared to, and appeals most to, individuals. In the examples of successful crowdsourcing cited above, entrepreneurial success can come down to the vision of a single individual, and depend upon other individuals’ desire to connect and be part of something new.
In the relatively short time it took to write this article, new crowdfunding platforms have been launched, and with ever more innovative levels of sophistication for screening those looking to be financed and making the process smoother. While it’s all evolving quickly, the ultimate end is to make crowdfunding more the rule than the exception. And at its best it’s intended to be a winning proposition for all parties.