SMEs that want to develop new technologies and continue to remain innovative need to have access to adequate funding. These new technologies will force people to change jobs as some will become obsolete and others will be created as a result.
Due to the high level of uncertainty when creating new technologies, bank loans are harder to obtain. It’s difficult to guarantee ROI when you’re building something that hasn’t been built before.
This opinion is further endorsed by the Silicon Valley Bank (SVB) that has recently published the results shown in its Startup Outlook report, based on an investigation that saw the participation of startup founders from all over the world.
As a result, developing companies are finding it easier to obtain funding already in the early stages of life, a sentiment that had already been affirmed last year when, according to a survey published in December 2017, entrepreneurs were already convinced that this period is an excellent time to start a business, thanks to the ease with which you can raise capital.
What is crowdfunding?
Crowdfunding allows companies to bypass financial institutions for funding. It allows friends, family and supporters to fund companies that they believe in.
It also spreads the risk more evenly, for example, if a bank loaned a company £500,000 they alone take on all the risk. But crowdfunding spreads the risk so 500 people only have to put up £10,000 each to hit the 500k target, double the number of people and each person only has to put up £5,000. The bigger the crowd the smaller the risk to each individual that funds it.
There are four main types of crowdfunding.
- Donation-based Crowdfunding: This is when a company asks for small donations from a large number of contributors. A good example of this is the platform GoFundMe.
- Reward based crowdfunding: This is where a company has a clear funding target, and collects donations from a large number of people in return for a tiered reward system. The bigger the donation the bigger the reward. Examples of this are Kickstarter and Indiegogo.
- Debt crowdfunding: Also known as peer to peer lending. This is where loans are funded by people instead of a bank.
- Equity crowdfunding: Where investors can receive shares in the company in return for investing in it.
The advantages of equity crowdfunding
Equity crowdfunding is great for entrepreneurs that don’t mind giving up a percentage of their company to investors, in return for the investment it needs to grow.
This was initially a strategy for startups at the beginning of the Innovation Adoption Curve for investment, but due to technological advancements it has trickled down to less innovative businesses too.
An interesting way out for SMEs that can not get credit from the banking system, but also an alternative to the venture capitalists market.
Since 2012 equity Crowdfunding investments have doubled every year. In 2015, the total volume of global equity crowdfunding was $2.56 billion, according to the annual Crowdfunding Report, while in 2016 reached $4 billion.
It reached $90 billion 2017. It expected that this surge will continue until at least the end of the decade.
Based on these numbers, Forbes expects equity crowdfunding to far outweigh the volume of capital provided by venture capital firms by 2020.
In fact, venture capital investments have been relatively stable for years around $ 30 billion.
For the same conditions, the equity crowdfunding would also exceed the Angel Investment segment (around $20 billion per year) by 2019.
Regardless of the sector numbers, another reason that is allowing equity crowdfunding to gain ground is the low entry threshold in terms of costs, which is especially attractive for lean businesses.
According to a realistic cost analysis, between $ 40,000 and $ 100,000 needs to be invested in marketing and legal activities (e.g. filing patents) in order to raise $1 million.
According to the CEO of WeFunder Nicholas Tomarello, one of the the leading platforms in the sector, the legal and accounting costs related to the collection of funds would be around $2500.
The cost of using the various crowdfunding platforms, range from 4% to 10% of the total amount raised, however in this analysis we’re not taking into account the cost of marketing, which often can be much higher than the platform itself.
As I said a little while ago, what we could call “goodwill”, or personal brand, comes into play:
- How many people know the team behind the project?
- How reliable are these entrepreneurs?
- What have they already shown to be able to do?
The higher the value of startup, the less investment in marketing needed.
When should an equity crowdfunding campaign be activated?
The answer is complex.
The first part of the answer is asking more questions, for example:
What are the investor expectations? Are they:
- Rapid growth
- Steady growth
- Profitability within 2-5 years
Also, what ROI do they expect and in which time frame? Is this feasible for the business to achieve?
Also, how much risk are investors willing to take on? Are they willing to invest in a project that doesn’t currently exist on the market? Or are they keen to play it safe and invest in something that is more established?
Only after these questions are adequately answered can you answer the main question.
“Without guidance we can not look in the right direction.”
This is a great quote from the great Greek philosopher Plato, who summarizes how, in some moments of life it is important to have a guide that pushes us in the right direction.
Finding funding for your company is essential. But having a guide that teaches you how to find funding is even more so.
My experience as an investor in many startups, has taught me that regardless of the aspects seen above, if you are going to start an equity crowdfunding campaign you have to focus on what is relevant to an investor.
These things are:
- The level of innovation: understood as the ability of a start-up to present itself on the market, or in a sector with differentiating principles with respect to its competitors, and therefore a level of innovation aimed at improving something already existing.
- The Team: Any entrepreneur can have a great business idea, but they need to then build the right team around them to bring that idea to fruition.
- Economic and financial data: Investors will take a long, hard look at a company’s finances before investing. They need to know how much money a business is spending, what they’re spending that money on, how much they are making and what they are projected to make with and without their investment.
Equity crowdfunding is a viable alternative to traditional financing methods for SMEs. This opens the door for more businesses to become successful.
The next upcoming methods is STOs (Security Token Offering) which takes advantage of the blockchain to upgrade the current system of equity crowdfunding.