Crowdfunding: the latest craze in entrepreneurship

Finbarr Bermingham on an alternative way for young businesses to raise finance

"Crowdfunding: noun [mass noun] the practice of funding a project or venture by raising many small amounts of money from a large number of people."

The idea behind crowdfunding isn't new. Many well known businesses were launched with the help of financial contributions from the founders' friends and families. With the proliferation of social media and online transactions, however, crowdfunding has grown arms and legs and quickly established itself as an alternative method of raising the substantial levels of capital required to start a new business, to grow an existing one, or to launch a new product. Nowadays, it doesn't matter whether or not you have access to wealthy benefactors: you can take your idea online, put it to the crowd and, if it's strong enough, watch the capital roll in.

According to a report by Nesta, the UK's innovation foundation, £1.2 billion was raised worldwide through crowdfunding in 2011 via platforms like Kickstarter and CrowdCube - the figure is expected to double this year. In 2012, Nesta expects the number of platforms to grow by 60 per cent.

With banks reluctant to fund young companies due to the perceived risk, and venture capitalists and business angels (known as sophisticated investors) increasingly looking to make larger investments (usually over £100,000 for angels and £2 million for VCs), an equity gap has appeared - above the potential level of contributions from friends and families, below that of sophisticated investors. It's here that crowdfunding has been most successful. Smaller investors - some invest as little as 50p - are more willing to take risks and invest in something offering potential rather than immediate returns.

There are two main types of crowdfunding: reward and equity (others, such as donation and lending-based, are more niche). Reward-based crowdfunding first emerged through platforms like Kickstarter in the US and Bloom Venture Catalyst in the UK and under this model reward for investors is usually product or project based. Investors often receive a tangible product for their investment (for example, a watch), or something intangible with a certain prestige (perhaps a production credit in the film they've helped fund). With equity funding, by contrast, entrepreneurs offer investors a share of their business in exchange for capital.

Blooming good

Michelle Rodger is the co-founder of Bloom VC, a British reward-based platform which takes 5 per cent of any project it hosts. Anyone raising money through Bloom must be funding a specific project and those investing must receive a tangible reward once the project has been successfully funded. You can't plough the money back into your business without a visible end product, then, but can use it to launch a new product or to buy some equipment. Bloom's clients decide how much they want to raise and produce a pitch to attract investors, at which stage, Bloom will put their idea online.

Scottish jewellery manufacturer Bonnie Bling, for instance, raised £8,000 to buy its own machinery. Investors pledging £5 received a 10 per cent discount code, while those pledging over £500 were rewarded with a range of Bonnie Bling products, a 20 per cent lifetime discount and invitations to all the business's future events.

Michelle likes the fact that crowdfunding can help good business concepts get off the ground. "We knew graduates crammed full of brilliant ideas, but unable to get money to do anything with them," she says. The Bloom VC team took a conscious decision to pursue the rewards-based model: "We feel that the best thing to do [as a young business] is to hang on to your equity for as long as you can." Bloom advises its clients on creating an appealing pitch and on promoting their projects using social media, and makes sure they meet all the legal requirements. Michelle explains: "You get a load of extra benefits above the money. Once you've gone through the process, you're in a much better position to go for the next round of funding, if you choose banks or sophisticated investors."

Luke Lang co-founded Crowdcube in 2010, Britain's first equity-based crowdfunding platform. For him, crowdfunding is the digitisation of a model which has existed for centuries. Modern technology has simply made it more efficient. He compares it to charitable donations. For many years we've been putting spare change in collection boxes. The advent of sites like Just Giving, though, allows us to donate more securely and allows fundraisers to cast their net further. Crowdfunding, says Luke, performs a similar role for businesses.

Crowdcube has a more stringent admittance criteria than Bloom. Says Luke: "They've got to have all the information an investor needs to make an investment decision. They must have a well-written and presented business plan, accounting for scalability, marketing and management. They must have financial forecasts that actually add up."

The nature of equity crowdfunding and especially the stringent criteria potential participants must usually meet make it more attractive for serious investors. It may not offer the instant gratification of the reward model, but the fact that funders own a stake in a well-vetted business means that their long term returns can be much greater. For this reason, you're more likely to see large investments in equity-based projects than rewards-based ones.

Both models, however, present an opportunity for people who wouldn't usually invest to contribute to an idea that interests them, since your contribution can be as little as a few pounds. Luke says that those ventures that are easy to understand and which offer some kudos - something you can tell your friends about at dinner - have often succeeded.

Energy efficient

Oliver Morgan is a 20-year-old serial entrepreneur. In his short career, his businesses have involved products as diverse as solar panels, melons and video-based recruitment tools. His primary focus at the moment, though, is Universal Fuels: an oil and gas supplier that he set up while still at school and which is now one of the UK's top three fuel distributors. About 18 months ago, Oliver was trying to raise £100,000 for his business. A number of sophisticated investors had offered him the money in exchange for 50 or 51 per cent of his business when he discovered Crowdcube. The platform enabled him to raise the money in exchange for a much smaller share. He's currently trying to raise another £50,000 in exchange for 4 per cent of Universal Fuels.

Crowdfunding also offered the advantage of fitting particularly well with the quirks of the energy business. Oliver explains that "when you enter the gas and electricity market, there's a three-month period in which Ofgem do all the systems and admin checks. During this period, you can only take on 100 customers. Crowdfunding allowed us to find 100 shareholders who would also become 100 customers. It ticked all the boxes."

Laterally-thinking Oliver clearly has a wise head on his youthful shoulders, but his story shows the opportunities crowdfunding presents for young people in particular. It's a chance for those with limited business experience to raise finance unprecedentedly quickly and, if you do things properly, it can provide you with a crash course in communications strategy, financial planning, networking and more.

The message from all involved, however, is that you won't succeed on a whim. Says Michelle from Bloom VC: "My advice is to plan really, really carefully. Start to build up your social networking presence, reaching out to people and building a following. Engage the community around you so that when you launch the project you've already created a customer base."

Crowdcube's Luke Lang echoes those sentiments, saying: "The successful ones have a good business model and have put time and energy into their pitch. They also need a realistic valuation: it's amazing how many brand startups value themselves at £3 million, or something ridiculous. It's a good idea to surround yourself with a good management or non-executive director team. Your perceived weakness as someone in your early 20s might be your youth, so get those support mechanisms in place."