Getting in with the Crowd

Start-ups have to raise money, whatever the business there will be a need at some point. The biggest issue for most ishow.

Traditional options are Business Angels – wealthy individuals who provide capital and advice in return for equity, and venture capitalists who generally provide higher sums of seed but with harsher conditions. But, obtaining investment is very hard for fledgling businesses as these sources rarely part with money without seeing a proof of concept. For many businesses it is extremely difficult to get to this stage without any financial backing in the first place. Bit of a vicious circle you might have noticed. Secondly, because the options are so limited, such groups hold a lot of control over small businesses; an early stage start up never holds much bargaining power and the more desperate for money it is the worse the terms of investment are. It is in this way entrepreneurs quickly lose ownership and hence morale in their businesses. Clearly, this type of funding is massively in favour of the already rich and successful. On the other side of the coin, this also means only wealthy people have the opportunities to invest money in start-ups. In both cases the regular people seem to be losing out (what a shocker).

So, already I have highlighted two problems for entrepreneurship: one, start-ups face a huge uphill struggle to get that initial investment, and two, the masses have no platform from which they can invest in new projects. Not a very optimistic view if you fancy your foot on the business ladder. Cue the solution: crowd-funding.

It’s a pretty simple concept: lots of people each invest a small amount in a start-up, contributing to a big pot of overall capital. This means a company can obtain financing more easily and does not have to give a majority of equity to one person, the obvious appeal being that owners can retain more control over their business. Investors also do not need to commit huge amounts into one project therefore opening up investment opportunities to the general public i.e. the Crowd; hence the concept is aptly known as crowd-funding.

In fact people can tactfully “hedge their bets” by investing smaller amounts in many start-ups in the hope that even if some do not follow through there will still be an overall return. This is analogous to the way a venture capital firm works, essentially avoiding putting all its eggs in one basket by investing in several companies, knowing that just a couple need to boom to ensure an overall profit; except where Mr V.C invests £100,000 a time, John Smith is able to invest £100. This is a very attractive option for individuals who do not want their savings to stagnate in a bank account.

The model of crowd-funding has propelled the formation of “middle-man” companies who have seized the potential to design platforms from which this initiative is easily accessible for both start-ups and potential investors. Examples include Crowdcube, a UK leader, and AngelList and Prosper.com in America. A crowd-funding portal will typically allow start-ups to pitch their ideas and personalise their pages, which can then be searched for and viewed by individuals. An interesting new take on the world of social networking. Crowd-funding portals are innovating business financing even more by allowing companies to offer incentives other than equity, for example a new bar may offer free drinks to the investor if they put in a certain amount of capital. Rewards like this can also promote the start-up to a bigger audience and draw in supporters. There are even more obscure crowd-funding platforms such as those for public sector organisations like schools, or for artists, perhaps to raise money for a film production.

Another implication for crowd-funding is its ability to weed out start-ups that are likely to fail. If a start-up reaches its desired target is it more likely to succeed as a business concept? You could argue it is. In the case of traditional financing involving a small number of parties it is definitely plausible that those few investors have made a silly mistake, but when hundreds or even thousands of people have invested into a business it gives a sense of reassurance – surely that many people can’t be really stupid?

Crowd-funding: bringing a host of strangers together in one innovative meeting place somewhere in the depths of “the web” where they can join forces to drive the success of the newest business generation, and potentially reap the rewards. Is this the ground-breaking future of business financing? In 2011 alone $1.5bn was raised via online crowd-funding and I say why not put faith in the masses? We can’t all get it wrong.