The concept of “crowdfunding” was conceived in 2003 and has been gaining traction ever since.
Essentially, it is an alternative way for companies and start-ups to raise money without going to a traditional bank. Money is raised through an Internet platform which allows companies, startups, entrepreneurs and various projects to seek monetary contributions from a large number of people all over the globe. The question then becomes what motivates these people to contribute money.
There are several types of crowdfunding and several ways that people benefit from contributing money to a crowdfunding platform.
First, in a reward-based crowdfunding model, the entrepreneur pre-sells a product or a service to launch a new business concept. This type of funding is commonly seen with motion picture promotion, software development, invention development, scientific research and civic projects. Many people contribute money to projects they believe in because they want to feel that they had a part in something important and they have a desire for social participation.
For example, a Japanese rock band, Electric Eel Shock, raised money from its fans and in turn offered them a lifetime membership on the band’s guest list wherever they perform. The highest grossing crowdfunding reported to date has been by an online space trading and combat video game project called Star Citizen. They have raised over $82 million to develop their game.
Another popular form of crowdfunding is equity crowdfunding. Here, the backers receive shares of the company in exchange for their money pledges. Essentially, it creates a wide pool of small investors. This allows individuals to get in on the ground floor of companies in their early stages that are creating products or services that are exciting to the investors.
Another very popular form of crowdfunding is known as debt-based crowdfunding. This is also known as peer to peer lending. Essentially, borrowers apply for a loan online while investors buy securities in a fund that makes the loans to individual borrowers or bundles of borrowers. Investors make money from interest on the unsecured loans and the system operators make money by taking a percentage of the loan for a servicing fee. An example of this peer to peer lending is Lending Club. It was launched in 2006 and, in 2009, Google invested $125 million into this crowdfunding company. It went public in December 2014 at a valuation of $9 billion.
Crowdfunding has also developed as a fundraising tool for litigation. Individuals can invest in legal disputes on a global basis in exchange for a stake in the claim. This allows individuals to participate in litigation they are passionate about and at the same time make money from their participation. In return, it assists the litigation by providing the funding necessary to go forward.
In 2009, one of the more popular crowdfunding platforms launched was Kickstarter. This organization is an American worldwide benefit corporation out of New York that built a global crowdfunding platform focused on creativity. They have received more than $1.9 billion in pledges to fund more than 257,000 creative projects such as films, music, stage shows, comics, video games and food-related projects, etc. People who back Kickstarter projects are offered tangible rewards and one-of-a-kind experiences in exchange for their pledges.
Basically, the project creators choose a deadline and a minimum funding goal. If the goal is not met by the deadline, then no funds are collected. This operates as an insurance policy for the backers that what they support will go forward.
There are a number of benefits to crowdfunding over and above the financial gain. Crowdfunding can boost the reputation of a project initiator, it can help market the project and it can provide valuable feedback through audience involvement.
The biggest drawback to this type of fundraising is IP protection. Many interactive digital media developers and content producers are reluctant to announce the details of their project for fear that their ideas will get stolen. As such, they will not participate in crowdfunding.
Overall, it is evident that crowdfunding provides an extremely effective alternative to traditional bank lending while at the same time providing a wonderful avenue for individuals to get involved with exciting projects that would not otherwise be available to them. I am a huge proponent of this financing concept.
• Lisa Spiwak is a partner with the firm Spiwak & Iezza in Thousand Oaks. Reach her at [email protected]