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Why are more and more tech firms turning to crowdfunding?

Crowdfunding
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When Facebook bought virtual reality firm Oculus VR for £2bn (£1.3m) in 2014, the crowdfunding world looked on with amazement. Oculus, founded in California in 2012, had raised its crucial first $2m on crowdfunding platform KickStarter, and became the first crowdfunded business to be valued at over a billion dollars.

Crowdfunding, it was widely observed, had moved away from its original purpose – raising relatively small sums of money for creative ventures – into a bona fide means of raising revenue. Crowdfunding has grown massively in popularity since 2014, particularly within the UK tech market, where, due to the experimental nature of tech innovation, traditional bank loans can be hard to come by.

The UK ‘alternative finance’ market ended 2015 worth £3.2bn, according to London-based think tank Nesta, constituting 12% of lending to British small businesses. Donation-based crowdfunding grew by 507% over a single year, with equity-based campaigns seeing a 295% increase.

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Rising interest in crowdfunding

So why are UK tech startups becoming so interested in crowdfunding?

It’s all simple economics, said Justin Grainger, a crowdfunding consultant at CrowdFundMe2. In a world of post-recession government regulation, banks are even less willing than before to provide risky capital – and for a tech startup launching an experimental, innovative product, risk capital is just what they need.

This was certainly the experience of Tom Putnam, 30, who co-founded the London-based BeeLine in 2015. BeeLine produces handlebar-mounted electronic compasses designed to guide cyclists around busy cities by connecting with their smartphone’s map app.

“A bank loan just wouldn’t happen for our kind of company – a risky tech startup,” Putnam said.

He instead opted for KickStarter, successfully raising more than £150,000 in his firm’s first reward-based campaign in 2015. Backers were promised rewards within a year, which have now all been delivered. Armed with proof of his product’s popularity, Putnam was able to raise £500,000 in equity funding the following year, most of which came from institutional investors.

But it’s not just the initial injection of capital that Putnam – and other founders of British tech startups – likes about crowdfunding. After the success of its first campaign, BeeLine asked its backers to fill in a market research survey, with a 25% response rate giving Putnam an 800-customer-strong data set with which to work. This gave the entrepreneur and his co-founder crucial insights into their customer base and product appeal, he says.

“It wasn’t just demographics,” he explained, “it was things like, why would you want buy BeeLine, is it because it’s more affordable than other sat-navs, or is it because it opens you up to adventure and exploration?”

Equity vs reward

Putnam’s is, in many regards, the ideal story of what is described in crowdfunding circles as a reward-based campaign: when a startup offers physical products or ‘rewards’ to members of the public who donate funds. An equity-based campaign, in contrast, gives donors a share of the firm they are funding (albeit a very small one).

Perhaps the most famous example of equity crowdfunding in the UK is that of digital challenger bank Monzo, which last year claimed to raise £1m in 96 seconds – a public relations dream, with the ‘96’ figure making headlines across the country. The firm since raised a second round on Crowdcube, securing £2.5m.

The success stories told by Beeline and Monzo are by no means rare strokes of impossible-to-repeat good fortune, either. In a 2015 report, industry website AltFi and law firm Nabarro examined the performance of 367 companies that had used crowdfunding campaigns, and found that only around 20% had lost investors’ money. Given that 55% of SMEs fail within the first five years, crowdfunders cannot be blamed for their positivity.

But there remain, of course, a plethora of much less successful cases, which generally receive less attention from the crowdfunding world and beyond. London-based coffee delivery startup Pact Coffee, for instance, was forced last year to abandon its equity campaign with just days to go after realising it would not meet its £1m target. The startup, which aims to revolutionise the coffee market and launched its campaign on Crowdcube, told Business Insider there were “lots of small amounts going in”, but none of the “more sophisticated investors that make these crowdfunding campaigns successful”.

Pact_coffee

Pact didn’t have a great experience with crowdfunding

On the reward-based side, there are also plenty of nightmare stories of startups flopping before they can deliver any promised goods to their backers. The 2015 case of the Zano mini-drone, produced by the Wales-based Torquing Group, sent chills across the crowdfunding community when product testing showed serious issues with the device. This left the startup’s 12,000 KickStarter backers, who gave a collective £2m, in the lurch.

Grainger, however, believes this is not unique to crowdfunders, but is simply the risk of any contract. “I sometimes think that reward crowdfunding can get a bad rep when exactly the same things happen in the non-crowdfunded world for new products, and that doesn’t get the publicity […] It’s basically down the laws of contract – if you say you’re going to deliver something, then it has to be delivered when you say, and it has to work as you’d reasonably expect – that’s really no different.”

These nightmare scenarios do not seem to have dented the growing appetite for crowdfunding among UK startups, however, with Britain’s  top five equity crowdfunding platforms facilitating a combined investment of more than £48m in the first quarter of 2017 alone, according to business data platform Beauhurst.

Crowdfunding is certainly increasing in popularity in the UK, enabling startups to gain previously unattainable capital while also giving amateur investors a slice of the pie traditionally monopolised by professional investors and banks. It seems that we’re witnessing something of a new age in the democratisation of investment.

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