Understanding crowdfunding

Crowd goes boom!

No we’re not talking about that amazing tune from Jazzy Jeff and the Fresh Prince - we’re talking Crowdfunding. Crowdfunding has been touted as the biggest game changer in venture financing ideas since Acme Corporation backed Wile-E-Coyote in his dogged quest for a roadrunner roast dinner.

Year-on-year since 2012, crowdfunding in all its guises has grown a remarkable 100+% per annum with forecasts of similarly strong growth heading towards the back half of the decade and beyond.

Taking a step back, crowdfunding comes in a number of different guises nominally differentiated along two lines: non-financial return and financial return.

The first two are generally not for financial benefit to the pledger. The latter two – equity and lending (peer-to-peer, and increasingly, peer-to-business) – have an expectation of financial reward. Read on for a brief recap of each type of crowdfunding style and their main points of difference.

The arrows below step it out in pleasing aesthetics, I'm sure you'll agree:

Donation-based crowdfunding:

Aren’t you a nice person? This form of crowdfunding provides donations to charities and personal causes via crowdfunding platforms, and are often tax deductible. These could be direct to the charity to be used as they see fit or more commonly donations to support individual projects run by a charity (like act.), or for purely personal causes such as our favourite campaign, Midlife Crisis Squirrel Tattoo (link). Although we’re left feeling a little daft as we can’t differentiate between a squirrel with or without a midlife crisis. They both look like squirrels. Then again, what is the colour of wind?

Rewards-based crowdfunding:

By now you’ve probably had enough of this guff from us vis-à-vis our website profiles and features of shockingly successful campaigns. Just to whet that little whistle again, these campaigns generally offer a tiered set of rewards commensurate with dollar value to sweeten the stumping up of cash by the donor. Most commonly used as a pre-sales vehicle for new and funky products which is of enormous potential value to the entrepreneur in demonstrating traction and market interest.

Lending-based crowdfunding:

Often called peer-to-peer (P2P) and peer-to-business (P2B) lending, these are loans provided to either people or businesses for interest and repayment over a period of time. This has developed exponentially in the past few years but some providers are missing the “peer” part (namely, raising from financial institutions) and then onlending. Some are predicting this to be the biggest growth area in crowdfunding - the cash is easier to get a hold of if you need something urgent, like a new Sony, and the interest rates are competitive. And everyone wants a new Sony.

Equity-based crowdfunding:

Equity crowdfunding (ECF) is the new(ish) frontier.

Have an idea? Put a lot of hard work and effort into bashing it into shape? Need money to get over that hurdle and into a functioning startup?

You no longer need to shoehorn yourself into that suit you save for cousins’ weddings and present uptown at an investment bank only to be shot down by a gang of marauding millionaires high on the trappings of success. Sure you’ll need a business plan, pitch deck, constituent documents and all the things an investor (and business) needs, but now raising capital is pitched at your friends. And your friends’ friends. And their friends’ friends.

So, slap on the Dunlop Volleys, slick down that small-batch mo’ that’s trying to escape from your face, get your other fixie-riding mates in and shoot a cool and informative video plying your wares and put it up on the interweb to share and let the crowd power you. Then give ‘em a bit of your company in return. All in it together. Sweet as bro’.

Or is it?

Turns out there’s equity crowdfunding and then there’s equity crowdfunding.

There’s a bunch of legalese associated with just what types of ECF are allowed in each respective jurisdiction. The most liberal category of ECF (such as in NZ and the UK) is the all-in model whereby ordinary mum and dad (the so-called ‘retail’) investors can purchase equity directly in the private company.  At the other end of the scale (which is Australia), ECF is available, but generally only to high net worth ‘accredited’ investors or, as in our case, a mix of ‘sophisticated’ investors and a maximum of 20 ‘retail’ (mum and dad) investors for each private company. Then there are many shades and permutations of this including managed funds, unit trusts, syndicates etc.

We’re ultimately headed towards market liberalisation and the opening up of private company financing to retail-level investors so we consider that the “Holy Grail” of ECF for the time being so for our purposes we define ‘true’ ECF as available to all investors, not just accredited individuals.

Real estate crowdfunding:

Yeah this is a thing too – we think it’s lending, but it may be equity, or something else altogether. Really though, we’ve got no idea where it fits in so forget we mentioned it.

 

A growing industry

Figures from the latest Massolution 2015 Crowdfunding Industry Report published 31 March 2015 into the global crowdfunding industry are predicting big things for 2015 and beyond. Since 2012, the total industry has grown over 100% per annum and tipped to break the $30b mark this calendar year. Whilst rewards- and donation-based crowdfunding are showing steady growth through the 2015 forecasts, the real growth area in crowdfunding is in the financial reward sectors (lending and equity) which are tipped to continue the meteoric growth rates we’ve observed to date (167% for 2014 alone) to account for over 80% of the expected $34.4b global industry by year’s end.

No chump change, equity and loan crowdfunding are set to seriously disrupt traditional financing models and give the angels and VCs a run for their money – and in the best-case scenario, bring in these institutional and sophisticated investors alongside the mums and dads to fast-track startup and small business financing.

 

Well that’s it for now. We hope we’ve provided some grist for the ideas mill and stay tuned next time when we look beyond our borders and see what’s going on in the rest of the world – where equity crowdfunding is actually happening.

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