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CROWDFUNDING TAKES OFF
Think you have the next big idea but lack the resources to make it happen? Crowdfunding sites might be your best shot. Sites such as Kickstarter, Indiegogo, and RocketHub have led the growth of what has come to be known as rewards-based crowdfunding. The Internet is the ideal medium for crowdfunding because it allows individuals and organizations in need of funds and potential backers to find one another around the globe. For instance, Kickstarter is available for projects in 17 European countries, as well as the United States, Canada, Mexico, Australia, New Zealand, Singapore, Hong Kong, and Japan. Indiegogo is also focusing on international growth, with campaigns having been started in 235 different countries and territories to date. One of the biggest advantages of crowdfunding is the positive impact that it can have in funding projects in the developing world. According to the World Bank, the developing world has the potential to deploy up to $96 billion a year by 2025 in crowdfunding investments.
How do sites like Kickstarter and Indiegogo work? The idea is simple—an inventor, artist, or activist looking to raise money for a project uses the site to create a page for that project. The sites take a small commission, usually about 5%, on completed projects. Backers often receive some type of reward, often corresponding to the size of their contribution to the project.
Crowdfunding has become a resource for the development of films and videos, games, music, comics, art, and technology. For instance, in the United Kingdom, one of the top projects funded is a board game called Dark Souls, created by Steamforged Games Ltd., that raised almost £3.8 million from over 31,000 backers.
Successful crowdfunding projects typically share some common elements. One of the most important is a clear and concise presentation of the idea, especially through the use of video. The crowdfunding campaign is in many ways similar to presenting a business plan and should touch on the same eight elements of a business model, such as the project’s value proposition and its target market.
Not every crowdfunding project gets off the ground—Kickstarter reports that as of February 2021, only about 38% of its approximately 513,000 projects thus far have reached their funding goals. Sometimes projects that do get off the ground simply flame out, disappointing their backers. For instance, one of the UK’s biggest Kickstarter project, for the development of the Zano, an autonomous, intelligent, swarming nano drone, went bankrupt before ever completing its product despite raising about £2.34 million from over 12,000 backers. Kickstarter now requires fundraisers to disclose the risks associated with their project, including photos of prototype products (instead of simply drawings, simulations, or renderings) for inventions. Both Kickstarter and Indiegogo now offer project creators access to experts in design and manufacturing to help them better understand their costs and the feasibility of their products. But backers still have no real recourse with respect to projects that never get off the ground or have unresponsive founders.
A new use of crowdfunding is to provide seed capital for startup companies in return for equity (shares) in the company, known as equity crowdfunding. The United States has been a global pioneer in the development of equity crowdfunding. Under the JOBS Act passed by the U.S. Congress in 2012, a company can crowdfund up to $1 million over a 12-month period, and in 2016, the rules requiring potential investors to be accredited (having a net worth of at least $1 million dollars) were relaxed to allow smaller investors to purchase equity stakes of $2,000 or more. However, equity crowdfunding requires extensive compliance from businesses, with steep penalties for any irregularities, and potential investors are still subject to the usual risks involved in investing.
In Europe, the situation is more complicated. National laws in countries throughout Europe varied widely, with various countries each taking their own unique approaches, hampering the development of crowdfunding platforms and cross-border funding. As a result, the European Parliament developed new regulations that will enable crowdfunding platforms operating in more than one EU country to only have to comply with a single set of basic rules. The new rules will take effect in November 2021. The rules cover both loan-based crowdfunding (also referred to as peer-to-peer (P2P) lending) and equity crowdfunding, and they apply to all crowdfunding projects of up to €5 million. Reward-based crowdfunding similar to that offered by Kickstarter and Indiegogo and donor-based crowdfunding are specifically excluded. The rule requires that crowdfunding platforms provide investors with a key investment information sheet on each project as well as clear information about the potential financial risks of the project. However, although the new regulations are intended to create a harmonized regulatory environment, specific EU member-states may still impose additional regulations. For instance, in Germany, regulation of commercial lending activity is much more stringent than in other EU member states and will likely continue to be so.
Outside of the EU, there are a number of different regulatory approaches. In the United Kingdom, for instance, crowdfunding is regulated by the Financial Conduct Authority (FCA). Unlike in the United States, where legislation specifically enabling crowdfunding has been enacted, in the United Kingdom the FCA has relied on amending rules under the Financial Services and Markets Act 2000 to facilitate the development of crowdfunding. These rules went into effect in 2014. In December 2019, after the high-profile failure of Lindy, one P2P platform, the FCA implemented more stringent regulations designed to make sure consumers are better protected and that the P2P crowdfunding market is able to operate in a sustainable fashion. Three top UK equity crowdfunding platforms are Seedrs (the first platform to gain FCA approval), Crowdcube, and SyndicateRoom.
Australia has also enacted legislation that allows businesses to raise funds through crowdfunding with less stringent disclosure and reporting requirements than its regular securities regulation. Singapore has also eased the regulatory requirements on crowdfunding platforms, resulting in an increase in the number of crowdfunding platforms available.
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