Crowdfunding merits its hype as a tool for risk-takers

First published in the Financial Times on 21st October 2014.

The sheer variety and ingenuity of schemes that are seeking backing is inspirational

The two main reasons would-be entrepreneurs give me as to why they haven’t started a business are fear of failure and lack of capital. But I think a solution is at hand – at least for the latter problem, anyway.

There is a revolution taking place in the financing of small companies. In the words of George Osborne, UK chancellor of the exchequer, crowdfunding – raising money from a large number of backers via the web – represents the “dawn of a new era” in how start-ups raise capital.
It really is a transformational tool. The number of projects capitalised in this manner is growing at an exponential rate – hundreds are being launched and funded every day. Globally, crowdfunding appears to be doubling every 60 days. For almost anyone wanting to raise the money to start a business or a social enterprise, I would advise them to investigate the crowdfunding route very seriously.

It must be said that most of the schemes being promoted on the many funding platforms are high risk. And some of the busiest platforms, such as Kickstarter and Indiegogo, do not offer subscribers shares, but rewards. In theory most ventures posted are in the nature of social campaigns and non-profit undertakings. But many are clearly companies: Oculus Rift, which raised $2.4m in 2012 on Kickstarter, sold out to Facebook for $2bn.

The fact that quite a high proportion of projects are for plays, books, films and music albums reflects the struggle many artists have in bringing their dreams to life. Now they can access online channels to solicit pledges for their creative endeavours. I have friends who have financed novels and musicals using Unbound and Crowdcube. Before crowdfunding, these might never have appeared – or taken many years to receive the necessary cash. Other platforms specialise in certain sectors. The Trillion Fund targets renewable energy, Property Crowd raises money for real estate projects, Hubbub finances educational ventures, and Gambitious supports independent game developers.

Meanwhile established companies are being advertised too. On Seedrs, a platform in which I’m a shareholder, an English sparkling wine producer called Chapel Down raised almost £4m recently from 1,400 investors. Discounts and special offers were also given to backers. The prospectus for this size of business was much more professional than most; but the board still employed a video to help sell the fundraising.

Part of the explanation for the sudden expansion of crowdfunding is very low interest rates. Investors are receiving poor returns on bank deposits, so they are searching around for other places to put their savings. Of course, punting money in crowdfunded projects is much more dangerous than leaving it in the bank – but also more exciting. Moreover there is no doubt that this novel form of finance means more new ventures, more job creation and more innovation. The sheer variety and ingenuity of schemes that are seeking backing is inspirational. Crowdfunding enables communities to come together and pursue good causes.

Institutional venture capital is expensive, scarce and generally rather risk averse. Experienced angel investors are much more plentiful than they were, but there are still too few of them. Bank lending is simply not the right type of capital to initiate most new enterprises. So there has always been a shortage of capital for seeding early stage ideas. This new digital ecosystem of microfinance is democratic, low cost and quick.

Inevitably, crowdfunding was pioneered in the US, but because of a legal logjam, the market there is semi-paralysed. This has enabled London to claim the crown as the world’s crowdfunding capital, thanks to light regulation and tax breaks.

Crowdfunding cannot offer the experience, mentorship and connections that veteran investors provide. Weak ideas will still fail to find the necessary backing. And many crowdfunded projects will go broke. But as an alternative to the traditional forms of finance for cash-strapped ventures, it represents a real breakthrough. It is a powerful boost to the environment for entrepreneurs – and creators generally. I believe in the years to come, crowdfunding will yield great economic benefits for its leading proponents, including the UK and the US.