Is Crowdfunding A Disruptive Alternative to Angel Investment? Latest Sale reports from the Technology Business Directory and covers investment news. Start ups and entrepreneurs are faced with a choice; angel investment for businesses that are established enough that they are beyond the start up phase, but are still early enough in the game that they can benefit from the capital to develop their products or fund a marketing strategy. Alternatively the Founder may prefer to crowdfund no matter what stage the business is at. The decision to crowdfund or not may also be due to the Founder’s desire to hold onto equity. We explore in this article the pros and cons of either or.
Mod Notebooks founders Jon Wheatley and Marshall Haas have always boldy claimed, “Our start up would probably die if we were in San Francisco.” Then there was the Draft (now re-named Mod Notebook) Kickstarter campaign. Jon and Marshall famously cancelled it after raising $5,000 of its $20,000 target within 24 hours and decided to fund the launch themselves stating that they had customer validation and still needed to make some modifications to the product.
They also promptly moved their business to St Louis, Missouri shocking all their Silicon Valley fans, especially as Jon had moved to San Francisco from the UK, appreciated what the city had to offer and was well known within the investment community. In their mind a move to St Louis meant they could keep 100% of their company. Staying in San Francisco meant they could not, so that is how they reached their decision to move across state.
With average monthly rents in San Francisco of at least $3,000 or £2,000 (and this is not for a luxury apartment either) the attraction of St Louis at just $700 or £450 a month for a luxury downtown apartment with private parking is understandable, as is the prospect of being able to afford to buy this same perfect apartment outright for less than $130,000 (£80,000) with a monthly mortgage if you so wish not to buy outright of $600 or £350 (yes six hundred dollars, that is three hundred and fifty pounds a month for your mortgage). If you don’t want to live downtown and you need more space you can buy a 1,800 sq ft 4 bedroom, two bathroom house with detached garage for two spaces instead, a little further out from the city centre and it is still around the same price, $600 a month will be your mortgage. You can also rent your own downtown office for $250 or £150 a month. We have all seen what happened to Boulder, Colorado which now ranks among the top 20 most productive metro areas in the USA in terms of GDP. Is St Louis, Missouri the next target on the map for tech entrepreneurs?
Alternative Business Funding Options
Scepticism amongst entrepreneurs towards investment is growing as alternative opportunities to fund their businesses such as US government schemes and incentives for businesses no matter what the nationality of the business Founder is continue.
Arch Grants
The Mod Notebooks founders discovered the Arch Grants scheme, set up in St Louis to attract aspiring entrepreneurs. The grant is a whopping $50,000 per business, and guess what…? It is equity free! So Marshall applied for this rare equity free funding via the Arch Grants Business Plan competition and won.
The Arch Grant’s mission statement is “To create an entrepreneurial culture and infrastructure to build successful companies in St Louis,” a city it claims that is full of happy job seeking college grads. Sponsored by the Missouri Technology Corporation, Bank of America, Emerson and Advantage Capital Partners among others, the annual Arch Grants Business Plan competition fund of which there were 20 winners in 2013 reached a whopping $1.2 milion in 2013. They even offered an extended bonus to two promising companies who could apply for a “follow-on equity free grant” of $100,000 each. Organisers of the programme claim that “taking venture capital forces an aspiring entrepreneur to sacrifice a significant stake in their company in exchange for funds. This process is often limited to ventures with access to the startup hotbeds like Silicon Valley, New York, and Boston.”
The funders of the Arch Grant do not expect start ups to have a huge team of Co-Founders either. They know as a start up budgetary constraints make this impossible and there is only so much free help one can expect to acquire from non salaried Co-Founders. As long as one person (the Founder) is prepared to work full time on the business, that is ok, so that the funds can be used across the business and the Founder can bring in remunerated part time staff as and when required. Once the Founder is ready for investment and needs other full time personnel to join, the programme offers a personal introductory service so the business owner can meet with potential investors who are suited to the personality traits and personal needs of the Founder’s business.
Arch Grant claims that St Louis, Missouri is now the fastest growing city for tech jobs and proclaim that applying for the grant is not just for residents of St Louis, it is for anyone and everyone, especially businesses with an international outlook.
To show how international they are in their outlook, Arch Grant organisers even successfully relocated grant winners simMachines from Costa Rica to St. Louis, organising their work permits and visas along the way. What is more important to Arch Grant is that the Founder/s is/are prepared to relocate to the United States immediately and live and work in St Louis, and yes, they will even help you find affordable accommodation.
Bloomberg Beta
Then there’s Bloomberg Beta, that specifically targets professionals with real life project management experience. On average these professionals have held or currently hold circa 10-15 years experience in senior Business Management roles in leading tech firms. Many of these professionals never thought of starting their own business in their 20s as they were too busy with their own corporate lives and day jobs. Bloomberg’s approach is unique and starts with identifying who these experienced professionals are and then inviting them via email to a Meet Up dinner with a whole bunch of VCs also in attendance. Some professionals who receive these dinner invitation emails from Bloomberg initially think it is a joke, but it is not!
Invitees are typically University educated professionals who have worked as employees in corporate companies during their 20s and early 30s. The programme seeks those with real life business experience even if they have not yet started their own business and those who have gained extensive project management expertise and knowledge of manufacturing and supply chain logistics in their field. The Bloomberg Beta $75 million (£45 million) venture backed scheme has been set up according to the team leaders to simply “meet tech professionals and just get to know everyone.”
The number of incubators and Business Accelerator programmes are also on the rise with many companies and even banks such as Barclays PLC, the Walt Disney Co. and Time Warner Inc.’s Warner Bros offering their own incubation programmes to encourage constructive dialogue between entrepreneurs and potential investors. Comparatively incubation programmes perform better for entrepreneurs than a solo crowdfunding campaign where support is limited.
The idea behind the Bloomberg Beta scheme seems to be led by the fact that Founders are waiting longer and longer before they seek investment, exploring every other fundraising avenue first. In an Erin Griffith article in Fortune, 1st August 2014, “Can you find Founders before they know they are Founders?” it was found during research that “By the time a founder sets out to raise a seed round, the startup’s valuation might be $10 million. One way to get around that is to invest even earlier. Invest before the company is a company.”
Microsoft Ventures Accelerator, London
Microsoft Ventures is an initiative that is designed to help business startups focus on business growth, development, industrial strength technology, and make viable and usable products. The fourteen week Microsoft Ventures Accelerator Programme is a fully fledged accelerator that gives entrepreneurs with established ideas mentoring, access to office space and key customers/ potential business partners. The programme also encourages dialogue between investors and entrepreneurs with a pitch presentation at the end of the three month period before a dozen investors, VCs, industry leaders on the panel during the Investor and Demo Day. The programme runs twice a year, each Spring and Autumn and accepts 12 companies for each cohort. The London Accelerator for high-potential tech and gaming UK start-ups opens its applications on 5th November 2014 for the next 2nd March to 5th June 2015 cohort.
Successful applicants are also eligible to receive up to £75k in equity funding prior to entering the Accelerator via a new fund, the JVM Tech Fund (Jenson Solutions Ventures in Motion).
As of 25th September 2014, 78% of the startups that went through the Microsoft Ventures Accelerator 2013 programme in London, succeeded in raising the seed capital required for their businesses, typically in the region of between $400k- $1.2 million. Compare this with Kickstarter’s success rate of just 7% when attempting to achieve crowdfunding backing for projects over $100,000. The Microsoft Ventures equity free programme also gives entrepreneurs the opportunity to raise their concerns prior to applying for the scheme and entertaining the idea of meeting with outside investors thanks to the Inside Microsoft Accelerator networking events held prior to applications are accepted for the next intake. These networking events enable potential applicants to meet with CEOs in Residence and the current start up cohorts in the Programme so they can further understand what it is really like being part of the Microsoft Ventures Accelerator.
Why Entrepreneurs Choose Crowdfunding over Seed Capital Investment
Convincing people from across the globe to fund a business is no easy task. However, if done properly, the business will have the capital required to make a start on a sound footing without relinquishing any equity. Entrepreneurs typically choose the crowdfunding option not only for the equity free capital but also for the audience or followers it will have access to as well as to acquire product or service validation. Many entrepreneurs also claim crowdfunding avoids the possible strained discussions with potential investors who simply ”do not understand their needs.”
Crowdfunding Success Stories
There are many crowdfunding success stories; Oculis Rift whose team already had development and manufacturing experience, industry testimonials and working prototypes before their Kickstarter campaign reached $2,437,429 of its $250,000 goal and was later purchased in March 2014 by Facebook for $2 billion. Pebble E Paper Watch for iPhone raised $10,266,845 of their $100,000 funding goal after failing to raise capital from traditional investors under their new Pebble brand name and within six days, the project had become the most funded project in the history of Kickstarter to that point, raising over $4.7 million with 30 days left in the campaign.
Problems with Crowdfunding
However not all creators are able to meet their funding goals. Kickstarter, the most successful crowdfunding platform has 42% of projects funded. If you dig into the data some more, these statistics give you an even better insight;
Projects with goals below $10,000 have a 38% success rate
Projects with goals below $50,000 have an 18% success rate
Projects with goals above $100,000 have a 7% success rate
According to Kickstarter, of the 2,796 games launched on their platform in 2012 (including tabletop games), 911 were successful. Technically, that’s a success rate of only 32.58%, so more than a 67% failure rate.
Indiegogo, second to Kickstarter has a 28% overall success rate according to estimations. So, even after all the hard work that the creator will have put in to promote their project on various crowdfunding platforms, there is less than a 50% chance of success if entrepreneurs go solo.
Developing the crowdfunding page is just the beginning. Raising awareness for the campaign, from press releases, regular project updates, to blogs and attaining media coverage is the key to success. Some entrepreneurs we spoke to even claimed that a $2,000-$5,000 investment in online advertising was the key to their success in raising over $100,000 for their Kickstarter project.
However, the huge awareness surrounding crowdfunding has opened the door to more competition and unscrupulous companies taking advantage of entrepreneurs who are trying to crowd fund. These “specialist crowdfunding PR companies” promise to raise awareness and generate press coverage overnight for as little as £200.00 only to fail to achieve these goals leaving entrepreneurs with high expectations short of cash with a potentially failed campaign and a lot of valuable time lost.
Most crowdfunding platforms encourage creators to look towards their peronsal network for intial funds, yet many of these personal networks firstly do not understand Amazon payments which Kickstarter uses in the US, neither do those most likely to back you have an Amazon account and neither do they fully understand why they need to give money via Kickstarter when they could easily put the money into their friend’s/ relative’s bank account.
It is best to “shark tank” a campaign first before crowdfunding it. A shark tank is a type of session where creators are encouraged to pitch the idea to critics who will give feedback on the project. This avoids potential problems such as failed delivery of products due to miscalculations in costings or manufacturing timelines and production issues. According to Business Insider, Kickstarter entrepreneur Jake Bronstein, founder of the Made in America Premium Men’s Underwear line Flint and Tinder, ended up with orders for 23,000 pairs of underwear, when he initially anticipated only having to make 3,000 units. He managed to honour the deliveries however the order was then delayed by several months and contrary to popular belief, the huge influx of orders (his funding goal was $30,000 and he raised ten times that, a staggering $291,493) did not go in his favour. As Kickstarter is very hands off and is nothing like Quirky a tech project support platform that has raised $68 million in funding, creators are not assisted post campaign with manufacturing issues and go to market strategies so they can actually start selling their product and ensure it is delivered on time. The Kickstarter campaign cost Flint and Tinder all the money raised taking into consideration the rewards to backers as well as manufacturing costs for a product the company had never manufactured before. To top this off, it also cost the company another $30,000 to fulfill all items to backers. The Flint and Tinder Founder had to turn to investor Tony Hsish, Founder of Zappos and others to help him out with an $850,000 investment.
Not all creators have the tenacity of Jake Bronstein and they simply give up when they hit problems. David Van Duzer who has backed over nine Kickstarter projects as reported in a David Vuong article in the Denver Post confirmed that he has only received three products out of the nine he has backed over the past two years.
The HD video recording glasses for Facebook Founder who raised $343,415 (much higher than their funding goal of $55,000) from 2,106 backers in July 2011, had not delivered the product 2.5 years after raising the money.
“The question isn’t whether or not you’re able to raise millions fairly quickly,” said Lynn Turner, a former chief accountant for the U.S. Securities and Exchange Commission. “The question is what do investors get back for the money that they put in? If 12 or 24 months down the road, it turns out that those investments don’t pan out and people aren’t getting a decent return, it’ll result in crowdfunding getting shut down just like the penny-stock markets got shut down.”
For equity crowdfunding projects, the Financial Conduct Authority (FCA) has proposed that inexperienced investors in equity schemes will have to certify that they will not invest more than 10% of their portfolio in unlisted businesses.
Due to the many crowdfunding campaigns that have reached their target but have failed to deliver the products on time or at all, Kickstarter now requires creators to issue refunds if the product cannot be delivered.
Kickstarter Legal Issues Update
Mob Rules Games launched a Kickstarter campaign for Haunts: The Manse Macabre in June 2012. The project was met with a positive response and reached more than $3,500 above the funding goal of $25,000. This success suddenly took a turn for the worst as the project Founder announced he had overestimated its delivery potential and was now left without developers or programmers to turn this game into reality.
To solve this issue, in May 2012, Kickstarter added additional guidelines and requirements for design and technology projects. Creators are required to provide information about their background and experience, the manufacturing plan and a functional prototype. This ensures that the creators have done their research before launching a Kickstarter and the backers have enough information to decide whether to back these projects or not.
Just recently, Kickstarter revised their terms and conditions due to the high numbers of creators abandoning projects and not issuing refunds to backers after several years. Creators are now obliged by Kickstarter to issue refunds if the project fails to meet its expectations otherwise they may be subject to legal action by backers. These new terms of use went into effect on 19th October 2014.