Crowdfunding is a hot topic in the lending and investing world, but with billions of dollars at stake for small businesses and startups it is not just an Internet trend that will fade away in the short term. Developments in the industry suggest crowdfunding will be a crucial part of supporting entrepreneurs for the foreseeable future.
Generally, crowdfunding refers to funding a project or business venture by raising money from a large number of people, usually over the Internet. While small businesses have always thrived on support from family and friends, often referred to as “angel” investors, when first getting going, crowdfunding has changed this model by using technology platforms to coordinate the lending of money from multiple parties, as well as tracking the method of paying the money back.
Crowdfunding is relatively young — the first examples emerged about a decade ago — and has been driven by Web-based companies such as Indiegogo, Kickstarter and SeedInvest.
Recent reports suggest there are approximately 1,000 crowdfunding platforms.
The industry still lacks clear tracking, but the most widely-cited statistics come from a 2013 study commissioned by The World Bank infoDev program’s “Crowdfunding’s Potential for the Developing World,” that examined the sector worldwide and estimated a global market of $96 billion by 2025.
By all accounts, crowdfunding first topped $1 billion annually in 2011 and has been steadily rising since, moving past a $5 billion-a-year sector now. The United Kingdom-based The Crowdfunding Centre is one organization starting to track the industry and released data suggesting more than $60,000 was raised hourly through crowdfunding platforms in 2014.
Crowdfunding services are also showing impressive numbers. Last month, officials at Kickstarter said the company raised $529 million for projects in 2014. Kickstarter appears to be setting the pace for the industry but others are not far behind.
For small businesses, all signs suggest that the real boom in crowdfunding is still to come. As the practice has grown, crowdfunding has spread to encompass many different models of funding, not all of which are designed to really impact a business startup, but the rise of the startup equity model of crowdfunding could be what triggers a real small business boon.
To date, crowdfunding has been driven mostly by these models:
- Rewards Model: Ventures and projects raise money from nonprofessional investors and the investors get a reward or perk, such as recognition of backing, but no ownership in the business or money back.
- Product Pre-order Model: Startups sell products before they are made, at a discount, in exchange for funding.
- Donation Model: Charities and creative projects get backing from investors looking to support the work. No startup ownership or financial return is expected.
- Debt Interest Model: Providing money for small businesses when banks are not an option, this model of microfinancing or peer-to-peer lending establishes a pool of money from which a lender can draw from, to be repaid with interest.
The startup equity model of crowdfunding sees investors put money into small business startups for an ownership stake — the risk being the investment only pays off if the business succeeds. If the business fails, the entire investment is likely lost. This model mirrors the traditional use of venture capital investors for startups, but on a crowdfunding platform would open the door to many different investors all over the world.
The only catch is that it is yet not legal in the United States.
Right now only accredited U.S. investors can invest in small businesses for an equity stake. Crowdfunding sites such as EquityNet allow accredited investors to do just that. Other sites such as UP America, Startups.co, AngelList and CrowdFunder match startups with professional investors and banks.
The hope is the government will open the door for nonprofessional investors to back startups for an equity stake, which could be a big windfall for first-time entrepreneurs.
The 2012 JOBS Act has provisions to make this happen, but the rules for doing so still need to be finalized by the Securities and Exchange Commission and there is no indication of when or if this will happen.
According to Richard Swart, director of University of California Berkeley’s Entrepreneurial and Social Finance research program and a partner at Crowdfund Capital Advisors, Congress will act to amend the JOBS Act in 2015 and get the ball rolling on equity crowdfunding.
In his predictions for the crowdfunding sector in 2015, Swart also suggests that corporate America will continue to expand its use of crowdfunding, both to funding its own product development but also to invest in other startups that could turn into potential acquisitions or partners.
He also points out that major companies will launch their own crowdfunding business models. YouTube is already doing this, with eBay, PayPal, Amazon and Facebook on track to do so as well. As these online giants enter the marketplace, the options for funding will dramatically increase for small businesses.
Swart predicts that the crowdfunding industry will continue to grow at least 100 percent a year.
With the rewards model of crowdfunding, in particular, becoming a very crowded segment of the industry and growth their likely starting to stall in the U.S., the debt lending and equity stake approaches could see the brunt of the new growth — with small businesses likely benefitting the most.
