Let's get together: crowdfunding portals bring in the bucks
TMT Predictions 2013
Deloitte predicts that crowdfunding portals will raise $3 billion in 2013, double the $1.5 billion raised in 2011.
Crowdfunding portals are websites that enable large numbers of individuals to financially support a project or company, with each backer contributing just a small percentage (generally less than one percent) of the total funding. A typical crowdfunded project has thousands of backers.
Crowdfunding’s growth matters to TMT for two reasons. First, some crowdfunded projects raise funds for new technological devices and media content such as computer games. Second, the portals themselves are likely to become a new type of Internet portal.
Media coverage of crowdfunding tends to focus on its role as an alternative to traditional venture capital (VC); however, there is much more to the concept. In fact, there are four distinct categories of crowdfunding that vary by type of portal and capital raised.
Categories of crowdfunding portals
Consumer lending is the largest category. Financial institutions and payday lending companies have for many years lent small amounts of money at relatively high interest rates to consumers with bad credit histories. Now, these services are available online through crowdfunding. In the five years between 2008 and 2012, crowdfunding portals likely lent more than $1.5 billion. In 2013 these loans are could to exceed $1.4 billion, up more than 50 percent from 20121.
Reward-based is the second largest category of portal. Individuals go to a website and support a specific project in exchange for a reward. For example, those assisting with the development of a computer game may get a copy upon completion. Those investing more may receive a basket of games and a T-shirt. Backers of a new kind of remote-controlled light bulb might receive a quantity of light bulbs, depending on the level of investment made. Backers of a new play might get tickets to the opening; more generous patrons might be invited to a champagne reception. This category could raise more than $700 million in 20132.
The next biggest category is the donation market. This overlaps with the reward market: many artistic endeavors that use reward crowdfunding also encourage funders to contribute very small amounts of money, typically less than $25, without expectation of a return -- except for the knowledge of having contributed to a worthy cause. Donors often receive a thank you in a program or liner notes. Traditional charities usually request donations to support their overall mission, and then decide for themselves how to allocate the funds. Crowdfunding portals can raise funds for individual projects, meaning donors can give to the project of their choice. This market may be worth more than $500 million in 2013.
Venture capital, which gets the most media attention, is actually the smallest category. Traditionally, early stage startup companies are initially funded from credit cards and savings, and then reach out to friends and family. This usually covers the first $250,000. Beyond that point startups look for money from individuals (angels) or established venture capitalists, with the first seed round raising perhaps $500,000. Expected changes in North American securities regulation could make it possible for companies to raise money via a crowdfunding portal62b, with contributors receiving an equity stake in the company. This category is the wild card for 2013. It could raise more than a billion dollars if the rules change, but less than $50 million if they don’t.
Crowdfunding generally involves small contributions at the individual level. Although the top pledge packages can be more than $10,000, on average the individual contribution is likely less than a thousand dollars in almost every category3. The funds raised for a particular project or investment tend to be in the thousands or tens of thousands of dollars, although on rare occasions they can be in the millions. For example, on one of the better known crowdfunded reward sites only 17 projects raised more than a million dollars and only two raised more than $ five million4.
Still, across tens of thousands of projects and investments, the total funding can really add up. In the past five years, the 30 largest lending portals raised more than $1.5 billion5. The largest reward platforms collected nearly half a billion dollars cumulatively. Donation sites raised hundreds of millions of dollars. Venture capital portals raised just tens of millions of dollars, but that number is expected to rise dramatically in the near future6. In aggregate, crowdfunding portals are already a multi-billion dollar industry, growing at more than 50 percent a year.
That being said, the $3 billion that crowdfunding is expected to raise in 2013 remains small compared to comparable funding mechanisms. Traditional venture capital raises about $40 billion annually7; charitable giving was almost $300 billion in the United States alone in 20118, and the pay day loan market in the United States was worth more than $50 billion in 20089. In each category, crowdfunding is growing much faster than traditional sources of funding, but still represents less than one percent of the total.
Given crowdfunding’s impressive growth rate, it is worth looking at some illustrative examples. The reward-based market is expected to have the greatest impact on technology and media developers. In May 2012 a company sought $100,000 via a popular reward-based portal to make 1,000 programmable watches, but ended up collecting $10.3 million from 68,929 people – an average of $150 per investor10. Most reward-based projects have tended to be for consumer products such as watches, smartphone accessories or games. In one recent survey, seven of the top ten products fell into these categories11. But there are many exceptions. Some non-consumer technologies, such as multiple-core chip architectures, also use the platform12.
Equity-based crowdfunding is often discussed as an alternative to VC for small to mid-size firms. Growth is accelerating as new platforms are launched, investor interest rises and regulatory constraints are reduced. In the United Kingdom, there are several platforms that provide equity-based financing for startups and growth capital13. In the US, a large crowdfunding portal raised $15 million in venture capital to pursue expansion into equity crowdfunding14. In Canada, an alternative stock exchange has publicly stated its support for crowdfunding15 and a provincial government is contemplating an exemption to the accredited investor rule for crowdfunding sites16.
Despite these advances, and even if VC portals become larger due to beneficial regulatory changes, they may still only capture a small share of the VC market. Startup companies value the intangible contributions such as knowledge and networks that an experienced VC provides. Also, regulations protecting casual (non-accredited) investors may remain in place for many jurisdictions. Finally, investor enthusiasm may be dampened once crowd investors experience their first ‘burn’.
Crowdfunding will more likely have a role in complementing traditional VC, generating additional capital at the ’friends and family’ stage of funding that generally precedes VC involvement. Indeed, crowdfunding could benefit the ‘A round’ market (where startup companies usually first try to access institutional money; typically for one to three million dollars) by helping more start-ups establish proof of concepts and secure their first paying customers. Further it could enable VCs to skip the riskier and more laborious early stage investing that many would rather avoid. In a recent survey, seed financing from VCs was down almost 50 percent year-over-year17, indicating that there may be a funding gap for crowdfunding to fill. Crowdfunding also brings the potential for more democratic or broader access to capital for startups and innovators without personal connections to capital.
The Jumpstart Our Business Startups (JOBS) Act in the United States has added to the excitement surrounding equity-based crowdfunding by requiring that the US Securities and Exchange Commission (SEC) consider the creation of new classes of investors who could participate in venture-like financing, in addition to the existing ‘accredited investor’ class. The SEC could decide to significantly loosen the rules, which would likely attract billions of dollars. However, there are many concerns about investor protection, disclosure and the potential for fraud77. If regulators don’t alter the rules in a meaningful way, or if they add new barriers, the equity crowdfunding market is likely to remain small. It is unclear at the time of writing what the outcome of the SEC process will be, or even when a decision will be made: it was supposed to be by January 2013, but by mid-December there were media stories suggesting that deadline will not be met18.
If regulations around equity crowdfunding are relaxed, there are likely to be increased risks -- and not just for investors. While crowdfunding may open the floodgates, capital will largely flow to inexperienced inventors and project managers. Crowdfunded projects have a history of unanticipated delays as inexperienced teams struggle with project deadlines and manufacturing details19. Some research suggests that crowdfunded opportunities are a bigger risk than traditional IPOs, and that the potential for the average investor to misunderstand or misinterpret the promises of an early-stage startup are higher than for an experienced accredited investor20.
There are also risks for those who participate in reward-based projects. The time elapsed between contributing money and receiving the reward or product may not be very long, but it is longer than scooping a similar item off the shelf of a retail store, and during those few weeks or months the funded product may become obsolete, as happened for some iPhone-related projects when Apple switched to a new kind of connector21.
In the computer gaming industry, crowdfunding portals could be an important source of funding –primarily for smaller titles that need millions of dollars, not hundreds of millions22. But given the uncertain nature of the creative process, many game projects never get finished, take longer than expected or need more money. Crowdfunders are unlikely to be happy with any of those outcomes23.
1 Deloitte Touche Tohmatsu Limited estimates based on existing knowledge, conversations with industry players and published industry estimates
2 Source: Crowdfunding Platforms Raise $1.5 Billion and Successfully Fund One Million Campaigns in 2011, Finds Research Firm Massolution, Market Wire, 8 May 2012. See: http://www.marketwire.com/press-release/crowdfnding-platforms-raise-15-billion-successfully-fund-one-million-campaigns-2011-1654020.htm
3 Based on Deloitte Canada review of multiple crowdfunding portals.
462b Source: Information Regarding the Use of the Crowdfunding Exemption in the JOBS Act, see: http://www.sec.gov/spotlight/jobsact/crowdfundingexemption.htm
The gaming category was responsible for nine of the 17 million dollar plus raises.Source: The most funded projects in Kickstarter history, Kickstarter, 28 November 2012. See: http://www.kickstarter.com/discover/most-funded?ref=sidebar.
5 Deloitte Canada analysis of publicly disclosed crowdfunding portals. The amounts we cite are likely to be lower bounds.
6 Deloitte Canada analysis of publicly disclosed crowdfunding portals.
7 Source: Global Venture Capital Volume Up in Q1, Deal Number Down, Science Business, 4 May 2011. See: http://sciencebusiness.technewslit.com/?p=4150
8 Source: Giving Statistics, Charity Navigator, 2012. See: http://www.charitynavigator.org/index.cfm?bay=content.view&cpid=42
9 Driehaus, B. (2008, September 7). Some states set caps to control payday loans. New York Times, p. A18.
10 Source: Some States Set Caps to Control Payday Loans, The New York Times, 6 September 2008. See: http://www.nytimes.com/2008/09/07/us/07payday.html?_r=0
11 Source: Crowdfunding video games, The Economist, 8 September 2012. See: http://www.economist.com/node/21562213
12 Source: Spurned by VCs, a ship startup turns to Kickstarter, GigaOM, 27 September 2012. See: http://gigaom.com/cloud/spurned-by-vcs-a-chip-startup-turns-to-kickstarter/
13 Source: Raising business finance through online investments, Crowdcube, 2012. See: www.crowdcube.com
14 Source: Indiegogo Raises $15 Million Series A To Make Crowdfunding Go Mainstream, TechCrunch, 6 June 2012. See: http://techcrunch.com/2012/06/06/indiegogo-funding-15-million-crowdfunding/
15 Source: Trading Summary, Alpha Trading Systems, 2012. See: http://www.alphatradingsystems.ca/
16 In the United States, securities regulation is principally a matter of federal jurisdiction under the SEC. In Canada it is under provincial control, through various Securities Commissions. Source: Ontario examines ways to loosen crowdfunding rules, The Globe and Mail, 29 November 2012. See: http://www.theglobeandmail.com/report-on-business/small-business/sb-money/business-funding/ontario-examines-ways-to-loosen-crowdfunding-rules/article5781219/
17 Source: Where’s the Venture Capital?, Chief Executive Group, 11 July 2012. See: http://chiefexecutive.net/wheres-the-venture
18 Source: Small Businesses Await Crowdfunding Rules, The Wall Street Journal, 12 December 2012. See; http://professional.wsj.com/article/SB10001424127887324339204578173731988591450.html?mod=WSJ_SmallBusiness_LEADNewsCollection&mg=reno64-wsj&utm_source=buffer&buffer_share=a7755
19 Source: Crowd-funding dark side: Sometimes investments go down drain, USA Today, 14 August 2012. See: http://usatoday30.usatoday.com/money/markets/story/2012-08-14/crowd-funding-raising-money/57058678/1
20Source: Crowd-funding dark side: Sometimes investments go down drain, USA Today, 14 August 2012. See: http://www.usatoday.com/money/markets/story/2012-08-14/crowd-funding-raising-money/57058678/1
21 Source: Kickstarter’s Obsolescence Problem, Illustrated By A Fantastic iPhone Cable I’ll Never Use, TechCrunch, 26 September 2012. See: http://techcrunch.com/2012/09/26/kickstarters-obsolescence-problem-illustrated-by-a-fantastic-iphone-cable-ill-never-use/
22 Source: Video game raises $4 million through crowdfunding, EtonDigital, 18 October 2012. See: http://www.etondigital.com/video-game-raises-4-million-through-crowdfunding/
23 Source: Crowdfunding’ should be a red flag’ to backers, Develop, 3 October 2012. See: http://www.develop-online.net/news/42140/Crowdfunding-should-be-a-red-flag-to-contributors