Crowdfunding model

Image by Rocío Lara

The UK is a nation of entrepreneurs. Ordinary people across the country have great business ideas every day and in 2013, 500,000 of them became a reality.

And not all of those businesses received funding in the ‘normal’ way. While entrepreneurs for decades have been taking out business loans, re-mortgaging their homes or borrowing from family members in order to fund their dream, there is now a different model for business funding, one which reflects our modern society.

The economy has become increasingly ‘collaborative’ with sharing and entrepreneurial sites like Etsy, eBay and Craigslist hugely popular. The relationship between businesses and consumers is changing and this is reflected in the popular funding model of crowdfunding. Ordinary people are interested in becoming more involved in business and are often keen to support start-ups in a variety of ways – from a small donation in return for a t-shirt, to a larger contribution in return for a share in the company.

Crowdfunding began as a way of funding mainly creative or not-for-profit organisations but since the economic downturn made it hard for businesses to get a loan, crowdfunding has stepped up to fill the gap.

According to Nesta, the innovation charity, 2013 saw £500million generated for small businesses via crowdfunding. Julia Groves, chair of the UK Crowdfunding Association predicts a promising future for crowdfunding saying that “the sector is primed to go on and completely replace aspects of retail banking.

What is Crowdfunding?

Quite simply, crowdfunding is a way of getting funding for a business venture or project from the ‘crowd’ – the general public. Once your pitch is on a crowdfunding platform, funding could come trickling into your pockets from literally anyone from around the globe. Independent people choose to invest in your business because they see great financial potential, or if they just love your business idea or product. Of course, the company offers the investor something in return too and this could be anything from a small stake in the business to a membership, or novelty product.

You can see in this Business Funding Guide how crowdfunding compares to the other types of funding available to start-ups. It’s certainly one of the newest and fastest growing models out there and while it won’t work for everyone (for example 12% of Kickstarter campaigns never get a single pledge), it has provided many small businesses with the boost they need.

Types of Crowdfunding

While the principle of crowdfunding remains the same, there are lots of different crowdfunding platforms out there. However, for businesses, you can break them down into three main categories:

Pledge based – these platforms allow entrepreneurs to pitch an idea, which visitors to the site can then pledge support to. Kickstarter is one of the most popular pledge-based platforms.

Equity based – these platforms allow investors to buy an equity stake in the business. As a result, the business gets funded and they get a return on their investment if the business is successful. Sites like Seedrs and Crowdcube are some of the most popular in this category.

Loan based – crowdfunding is also a way to get a loan, which bypasses the banks. Individuals, cities and organisations can lend money via a crowdsourcing platform – for example SoMo Lend does this well.

It’s also worth pointing out that there are retail-orientated platforms too like Crowd Supply. Aimed at aspiring retailers, the site converts your campaign page into an ecommerce page once funding is successful.

Success Stories

Obviously, if you’re starting a crowdfunding campaign, success is not guaranteed. For instance, only 44% of Kickstarter campaigns and 10% of Crowdcube campaigns reach their funding goal.

But if you’ve got an innovative product or idea, along with an inspiring pitch, there’s the opportunity there to think big and achieve.

For example, Kano launched a campaign that became the most crowdfunded idea ever – they raised $1.5million in just 30 days. Using Kickstarter, the campaign quickly grabbed attention and pulled on the purse strings of thousands of investors around the world, including Apple co-founder Steve Wozniak.

Their idea, a computer which you can build yourself like Lego, is up and running all thanks to cash from the crowd.

Co-founders Alex Klein and Yonatan Raz-Fridman explained the secret to their success to The Guardian.

Potential Risks

Critics of the crowdfunding model claim that the open, free-for-all approach is inherently risky. The combination of inexperienced investors and first-time business ventures is thought by some as a recipe for disaster.

However, no business venture is without risk. But the Financial Services Authority are concerned that the extent of the risks are not made clear to investors.  For instance, between 50 and 70% of all start-ups fail in the first few years.

The FCA has recently proposed a new rule that inexperienced investors will have to certify that they will not invest more than 10% of their portfolio in an unlisted business – a proposal which has been met with some criticism by Barry James, founder of The Crowdfunding Centre.

Other potential risks to the entrepreneurs themselves are that some may feel uneasy about exposing their venture to the world before it’s up and running, particularly if they think they’ve got an idea so novel and unique that it’s at risk of being stolen and copied.

The Changing Business to Customer Relationship

What’s most interesting about the crowdfunding model is that it goes beyond the practical application. The invention of crowdfunding has changed the relationship between businesses and consumers. Instead, crowdfunding creates a more ambiguous relationship where your customers could also be your shareholders, your enthusiasts and your promoters.

Perhaps most interesting is the idea that your customers will want to promote you. If you think about it, everyone who has backed you has done so because they love your idea. And even if they’ve only pledged a small amount, they’re still invested emotionally in your business. As a result, your initial backers become your customers and then your advocates in a strange blend of marketing and retail.

Crowdfunding is an example of a creative and collaborative economy, where anyone can pitch an idea to the crowd. It can help start-ups, whilst giving a wide range of people the opportunity to be involved in a new business venture.

Have you had any experience using crowdfunding for a start-up? What do you think the future holds for the crowdfunding model? Share your thoughts in the comments.

Read more: How America Works: Crowdfunding for Equity