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Main Content
Internet Capital Sourcing Model Gives Hope to Small Businesses
The controversial financial model ‘crowdfunding’ looks set to change the field for small business, social enterprise and even the arts
Also known as crowd financing, crowdfunding is a capital-sourcing system which involves seeking small investments from large numbers of the general public via the internet. While this is not a new concept (it has long been used by charities, especially for disaster relief campaigns) this financial model is increasing exploited to fund an ever diversifying range of business initiatives, charitable endeavours and creative projects.
The concept is set out very simply on the UK based crowdfunding site CrowdCube: small investment x a lot of people investing = successful funding. Entrepreneurs such as gadget makers create online pitches for their businesses, which are then promoted to potential investors during a limited time. Projects on the site currently include the UK’s ‘first hangover cure’ and seaweed cultivation farms. Ideas are exposed to vast and diverse numbers of people, rather than just the bank manager, making the chances of finding like-minded small investors much larger. It is a good way to test the market, increase publicity and garner feedback, as projects can benefit from the intellectual input of the ‘crowd’. There is also the chance they could go viral.
Rebecca Corey is using Kickstarter, an American platform for creative, artistic and social projects, to fund the digitization and promotion of more than 100,000 hours of East African music from Radio Tanzania archives. ‘I think it's fair to say that artists always struggle more than they should to be able to do their work free from financial constraints’ she says. ‘Kickstarter gives us an incredible platform to spread awareness about our project and raise funds immediately, as well as giving us direct, individual connection to our backers.’
In America and other countries, legal restrictions mean that crowdfunding remains for the moment philanthropic. ‘Investors’ in Kickstarter can only receive token ‘rewards’, such as a CD or T Shirt. In the UK however it is legal for investors to receive direct equity, which is the case on CrowdCube. Anybody can therefore start to build an investment portfolio by backing ideas which personally inspire them, including local business, while small start-ups which may never have previously got off the ground now have a fighting chance.
Starting a crowdfunding site is even a business opportunity in itself. Sites typically take around 5% of the amount raised by successful projects and the increasing presence of crowdfunding on the internet means that is sure to continue to attract advertisers.
Many in America believe that opening up crowdfunding to small businesses in this way will provide much needed job creation and innovation to the flagging US economy. The idea has wide and, unusually, bipartisan support in Washington. The House of Representatives passed a bill by 407-17 on November 3rd last year which would give small enterprise access to crowdfunding. The Entrepreneur Access to Capital Act , introduced by Republican senator Patrick McHenry, would change current law to allow anyone to invest in a company, within limits.
Under U.S. Securities and Exchange Commission (SEC) current rules, which date back 80 years, small businesses are limited to seeking capital from wealthy accredited or so called ‘sophisticated’ investors only. The new legislation, which is now being considered by the Senate, would lower the barriers to raising small amounts of money by permitting firms to raise up to $2million annually from small investors. These individual investments would be limited to $10,000 or 10% of an investor’s income. It would also eliminate the application of the SEC’s ban on the general solicitation of investment from those other than rich accredited investors.
So what are the drawbacks and should investors fear the doom-mongering articles that have sprung up in response to the bill?
From a company’s point of view, crowdfunding is by no means an easy ride. ‘Our experience so far has been exciting, rewarding, and at times anxiety-ridden’ continues Rebecca. ‘It takes a lot of time and energy and requires a great amount of effort and sustained commitment’. If the target sum is not reached within the deadline, the project is closed and investors lose nothing. While this is good for them, it is of course a drawback for those running the project. While the public’s input can be extremely useful, non-experts could do more harm than good with their contributions. Ideas are exposed to all and sundry, meaning they may get stolen. Although it can be highly successful for funding dynamic, one-off projects and a great way to test the market, crowdfunding is much less reliable as a sustainable source of capital.
From the investor perspective, critics also fear that if crowdfunding grows too much and too fast without sufficient restrictions, it will increase a potentially dangerous speculative attitude, causing investors to spend money they do not really have. The exposure of inexperienced investors to massive fraud is also a serious and real concern, which caused Senator McHenry’s bill to undergo several amendments before it was passed.
Of course the internet is a haven for fraudsters, but the small minimum investments, £10 on CrowdCube and $5 on Kickstarter for example, mean that investors need not be exposed to high risk. The fact that crowdfunding does not suit everyone just means that users of the system have to take time and care in considering whether a particular site is the best way forward for an individual project. The vast number of them means that quality varies, but is also a testament to the model’s success.
As with anything on the internet, it just takes common sense and a bit of thought and research. Almost everything in life is risky, and in this case, the rewards can easily outweigh the dangers. In an age of social networking and online micro payments, easy access to information and grass roots attitudes, laws drafted decades ago are outdated. With appropriate regulation, common sense and good research, crowdfunding can provide an inclusive and democratic approach to fundraising, which looks set to change the business world forever.