First there was ArtistShare. Then came IndieGoGo, Kickstarter, GoFundMe and a slew of sites that revolutionised the face of fund-raising. Crowdfunding, which has taken off in a big way in the United States, is still very much in its infancy in Asia, with only a handful of homegrown platforms like Crowdonomic, MoolahSense and Crowdtivate. Yet, with a rapidly growing economy of over $16.2 billion worldwide in 2014 (up from $6.1 billion in 2013), it is clear crowdfunding is here to stay and has much more potential waiting to be tapped upon.
Words by Lim Der Shing
Years ago, financing a business meant relying on bank loans, venture capital and borrowing money. Today, crowdfunding is turning that idea on its head, using the power of the Internet to help entrepreneurs raise billions in funding for everything from donations for music projects to equity financing for businesses.
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Now that I have been exploring this industry for a while, I would like to share some of my thoughts on business crowdfunding platforms. Speaking from the point of view of an investor, I believe crowdfunding works and there will be companies that do well. However, the market is not as big as, say, e-commerce, and growth will likely take a while. In fact, it is not immediately obvious (at least to me) that it will scale like Groupon clones or social media or sharing economy firms.
The Crowdfunding Marketplace
Several models of business crowdfunding exist. While some players rely on only one models, others engage in all three.
1. Rewards Crowdfunding
Reward-based crowdfunding makes good sense to me as a platform and for businesses who crowdfund. The downside to it, however, is that it encourages sleek marketing and over-promising at the expense of proper prototyping and testing. Improperly executed crowdfunding can end up in a PR disaster for both the company and platform, while the consumers end up getting nothing. One example would be the Buccaneer 3D printer project from Pirate3D, which fell short on delivery and is still unable to fulfil its orders to date.
Perhaps a good tweak would be to escrow all the monies and only hand out the dough when the product is delivered as promised. The firm can then use the promised sales to raise interim capital at their own risk. If the terms are breached, the platform returns the escrowed funds so that consumers are protected. Too bad for the company in this case, but at least only they suffer, which I think is fair.
2. Debt Crowdfunding
This model will likely end up attracting mostly middle-class and high-income professionals who may not fully understand the risk they are taking on. After all, people with more wealth to buy bonds directly will not be attracted to the 10 to 20% yields as junk bonds of >100M cap listed companies are yielding 10 to 15%. The extra few percentage of yield would not be worth the risk for them. Not to forget, the companies that raise crowdfunding are probably at 1M to 20M market cap at best, with a couple of million in revenue at most.
So if I were the authorities, I would be very cautious on debt crowdfunding. If companies fail, it would hit the crowd creditors who may have the wrong impression that debt is safe. Not true – debt to small unlisted firms is not safe. I doubt the crowdfunding platforms will warn people to fully understand the risks they are taking.
3. Equity Crowdfunding
This is the most complex and interesting model of crowdfunding. It’s somewhat similar to debt issue in that rich investors would probably do better sticking to angel investing, venture capital, or private equity funds especially for the tech industry. To me, equity crowdfunding will likely attract income professionals who wish to angel invest but have no deal flow or have smaller capital insufficient to meet the minimum 50k angel bite sizes. I hope these platforms do not target the middle-class, as early-stage private equity is not a suitable asset class for the average Joe. It is telling that MAS only allows accredited investors to invest in equity crowdfunding in Singapore. I think it is the right move.
As with debt crowdfunding, crowd investors will need to understand that this is an angel investment they are making with a 5 to 10% sales fee paid to the platform. Sad to say, most angel investments at such early stages fail. I doubt crowdfunding platforms will warn investors about this. Also, the investment is illiquid and cannot be sold or transferred easily. Most equity platforms plan to offer an exchange or work with one to allow some liquidity, but all that are just plans at present.
From a portfolio allocation point of view, I would encourage crowd investors to view this as highly-speculative positions in their overall portfolio. In other words, view equity crowdfunding as angel investing with a high change of getting nothing back. For debt, one may end up a party to the debt collection process. Note that private investment should be no more than 20% of total investible assets.
Furthermore, be careful in how the deal is structured. Special purpose vehicles could be set up for such deals, be it debt or equity funding, and both can have detrimental terms (such as not being allowed to sell or transfer equity as you wish). This is where a deal, in which there is already a professional lead, will come in helpful.
[Infographic Credit: InvestNextDoor via CrowdfundSuite]
Make no mistake, I believe crowdfunding is a viable way of raising money, and that for some suitable individuals (likely high-net-worth individuals up to 5M net worth), it is a new way to invest and offer deal flow. Angelist and Kickstarter are good examples of successful platforms, with the former being relatively high quality and having attracted venture capital money too.
But as is the case with any new channel, the industry will overpromise and some clearly unsuitable people may buy in. Plus, over time, the industry will seesaw until it finds its balance and a place in the entire funding ecosystem. My guess is that it will take 5 years to determine what the stable market state is like for our region. My bet is on it being much smaller than what many people may think, unlike the e-commerce or social media or sharing economy boom.
The biggest danger for crowdfunding, in my opinion, is its hype – too many negative stories of the average Joe losing money on such platforms due to badly-represented risks/rewards.
This article originally appeared on Lim Der Shing’s blog and has been republished here with permission.