Frank Newman: The wisdom of crowdfunding

The internet revolution is truly a revolution that has transformed almost everything we do - especially the way we interact with one another. That interaction is best manifest in social media like Facebook and Twitter to create a virtual viral grapevine. 

That connectivity is now being embraced by entrepreneurs and creative types seeking funding via the growing number of crowd funding companies.

Crowdfunding is generally defined as “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.”

Three participants are involved in the process:  the person with the project requiring funding, those individuals or groups that are prepared to financially support the idea, and the platform that creates the site that brings them together (and in return collects about 8%-10% of the funds raised as their fee).

There are literally hundreds of crowd funding sites and the number is growing exponentially, but the big daddy is Kickstarter. It has a 44% success rate of projects achieving their fund raising target. By comparison NZ sites like Givealittle, Pledgeme, Snowball Effect, and Boosted are minnows largely targeting niche markets.

There are two main types of crowdfunding websites: Rewards Crowdfunding and Equity Crowdfunding.

Rewards projects are where a product or service is in effect pre-sold based on a model or concept plan. Success means the project can go into production, knowing they have enough pre-sales to get the first production run underway. This is being embraced by the creative sector and with some musicians for example raising funds for an album or tour via their loyal fan base - a number of artworks in this years sculpture trail on Waihake Island were financed by artists via crowdfunding. Some writers and game creators also are having success.

And start-up companies are now seeing it as a funding opportunity via equity funding; which is where the many micro funders receive shares in the venture, and a share of the profits should it prove to be a success. Beer brewer Yeastie Boys recently raised $505k through Pledgeme from 212 pledgers, and drone designer and manufacturer Aeronavics has raised $1m so far from 191 investors, well above the $750,000 minimum they sought.

These funding success stories have come about as a result of a law change which came into effect on 1 April last year that permitted companies to raise up to $2 million a year in crowd-funding without having to issue a prospectus. As well as opening the door to crowd funding, the new regulations allow companies to raise up to $2 million from 20 investors in a year without needing to issue a (very expensive) prospectus or investment statement.

While Rewards and Equity crowdfunding are the most common other forms include charitable causes, and in litigious countries like the US litigants have used it to fund high profile civil actions in return for a stake in the claim. In the US crowdfunding is also being used as a means to fund what are in effect syndicated property investments, but without the rules and regulations and protections for investors - and therein lies added risks for investors.

There is no doubt the growth of crowdfunding will be of great interest to the many talented people who create goods and services but hit a wall when it comes to the funding and marketing. Online retailing opens the door to the latter, and crowdfunding may well open the door to the funding dilemma, if not right now then perhaps when the market is better developed in a few years.

It seems however, the new criteria of success is not just a good product, but something that ignites chatter and excitement on social media, so much so that a lot of people will part with a relatively small amount of money to support the project or cause.