Let’s get together: crowdfunding portals bring in the bucks
Deloitte predicts that crowdfunding portals will raise $3 billion in 2013, double the $1.5 billion globally raised in 2011.
Crowdfunding portals are websites that enable large numbers of individuals to support financially 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. Between 2008 and 2012, crowdfunding portals likely lent more than $1.5 billion. In 2013 these loans could exceed $1.4 billion, up more than 50 percent from 2012207.
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 2013208.
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 portal208a, 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 $100 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 category209. 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 $5 million210.
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 billion211. 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 future212. In aggregate, crowdfunding portals are already a multi-billion dollar industry, growing at more than 50 percent a year.
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 (nonaccredited) investors may remain in place for many jurisdictions. Finally, investor enthusiasm may be dampened once crowd investors experience their first ‘burn’.
Crowdfunding portals in the Middle East – The future looks promising
In the region, crowdfunding is taking its first steps with some exciting results. Aflamnah and Eureeca are two prominent portals which have established themselves since 2012. Crowdfunding portals charge a fee ranging between five to six percent of the funds raised and in some cases also charge a fixed fee to cover third party compliance charges.
Aflamnah brings Crowdfunding to the Arab world with huge ambitions to positively impact creativity
Aflamnah, the first digital platform dedicated to crowdfunding for creative ideas for and from the Arab world, launched on July 1, 2012. Since its launch, it has hosted 35 projects, captured media attention including international coverage in the New York Times, and won the 2013 Digital Studio Award for Best Innovation of the Year.
Aflamnah aims to help independent filmmakers, artists, geeks, students, innovators, thinkers and more to raise funds for their projects within 30, 60 or 90 days by getting people excited enough to financially support their idea so that they can make it happen. Aflamnah is for anyone who has an idea for the Arab world by Arabs or by individuals or organizations that care about cultures, societies and people who reside in any of its countries. It is also for anybody anywhere in the world who would like to support these projects because they fall in love with an idea, they just want to give something back to the community, or they are helping someone they know, or just because they want to. “When I Saw you”, a Palestinian drama directed by Annemarie Jacir, is an example of a project funded partly with crowdfunding at the critical post-production phase (refer Exhibit below).
Eureeca.com positions itself as an online marketplace213 where Middle East businesses source investment from the general public in exchange for equity. Eureeca. com offers new sources of funding to the region’s entrepreneurs in the small & medium sized enterprise (SME) sector.
Eureeca.com offers an alternative to traditional venture capitalism that will support entrepreneurial enterprise from start-up to global expansion of homegrown brands. There are more than approximately 200,000 SMEs currently in operation in the UAE alone. According to Dubai SME, the government agency mandated to develop the small and medium enterprises sector, not only do SMEs generate up to 46 percent of the UAE’s GDP, but they are also responsible for 86 percent of the country’s total employment. For as little as $100, investors can contribute to a business for which they will earn equity. For businesses, both start up and those seeking expansion funding, Eureeca.com presents a quick, convenient and unrivaled showcase to a vast potential investor audience.
To participate, businesses pay a nominal registration fee to cover a third party due diligence process that ensures compliance with ‘Know Your Client’. Business pitches remain on the Eureeca.com site for 90 days, and enjoy regular rotation on the site’s landing page to ensure maximum exposure.
Crowdfunding in the region 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. More significantly, crowdfunding can have an important role to play across the media value chain directing funds to areas of the ecosystem which are yet at a nascent stage e.g. mobile apps, e-commerce, payment platforms, mobile VAS and Arabic film production. Indeed, crowdfunding could benefit the ‘A round’ market214 by helping more startups 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.
Global Crowdfunding market – Some significant successes
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 investor215. 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 categories216. But there are many exceptions. Some non-consumer technologies, such as multiple-core chip architectures, also use the platform217.
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 capital218. In the US, a large crowdfunding portal raised $15 million in venture capital to pursue expansion into equity crowdfunding219. In Canada, an alternative stock exchange has publicly stated its support for crowdfunding220 and a provincial government is contemplating an exemption to the accredited investor rule for crowdfunding sites221.
In a recent survey, seed financing from VCs was down almost 50 percent year-over-year222, 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 fraud79. 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 met223.
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 details224. 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 investor225.
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 connector226.
In the media industry, crowdfunding portals could be an important source of funding – primarily for smaller titles that need millions of dollars, not hundreds of millions227. 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 outcomes228.
- Deloitte Touche Tohmatsu Limited estimates based on existing knowledge, conversations with industry players and published industry estimates
- 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. 208a Source: Information Regarding the Use of the Crowdfunding Exemption in the JOBS Act, see: http://www.sec.gov/spotlight/jobsact/crowdfundingexemption.htm
- Based on Deloitte Canada review of multiple crowdfunding portals.
- 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.
- Deloitte Canada analysis of publicly disclosed crowdfunding portals. The amounts we cite are likely to be lower bounds.
- Deloitte Canada analysis of publicly disclosed crowdfunding portals.
- Source: Eureeca.com brings crowdfunding investment model to the Middle East http://www.ameinfo.com/eureecacom-brings-crowd-funding-investmentmodel-305024
- Where startup companies usually first try to access institutional money; typically for one to three million dollars
- 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
- Source: Crowdfunding video games, The Economist, 8 September 2012. See: http://www.economist.com/node/21562213
- Source: Spurned by VCs, a ship start-up turns to Kickstarter, GigaOM, 27 September 2012. See: http://gigaom.com/cloud/spurned-by-vcs-a-chip-startup-turns-tokickstarter/
- Source: Raising business finance through online investments, Crowdcube, 2012. See: www.crowdcube.com
- 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/
- Source: Trading Summary, Alpha Trading Systems, 2012. See: http://www.alphatradingsystems.ca/
- 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/
- Source: Where’s the Venture Capital?, Chief Executive Group, 11 July 2012. See: http://chiefexecutive.net/wheres-the-venture
- Source: Small Businesses Await Crowdfunding Rules, The Wall Street Journal, 12 December 2012. See; http://professional.wsj.com/article/SB100014241278873 24339204578173731988591450.html?mod=WSJ_SmallBusiness_LEADNewsCollection&mg=reno64-wsj&utm_source=buffer&buffer_share=a7755
- 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
- Source: 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
- 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/
- Source: Video game raises $4 million through crowdfunding, EtonDigital, 18 October 2012. See: http://www.etondigital.com/video-game-raises-4-millionthrough-crowdfunding/
- Source: Crowdfunding’ should be a red flag’ to backers, Develop, 3 October 2012. See: http://www.develop-online.net/news/42140/Crowdfunding-should-be-ared-flag-to-contributors