Crowdfunding – migrating to a larger fish bowl

What is crowd funding? It is a new form of equity financing that enables a company to raise funding through small contributions from a large group of individuals via an online platform. So, is this relevant to us when the Main Street banks have traditiona

Crowdfunding is the application of a new concept in the orderly collection of funds through small contributions from many parties in order to finance a particular project or venture. For instance, equity crowd funding will help businesses obtain access to capital and historically it attributes its growth to a number of factors. Now the Commission is warming to the novel idea of how start-ups and SMEs can access finance at a time when mainstream banks tend not to be interested in assessing the risk profile of small companies, traditionally full of enthusiastic ideas but poor on collateral.

One may question whether crowdfunding can ever take root and flourish in Malta and, as it is a new concept, it will undoubtedly meet with obstacles albeit having fewer hurdles to overcome since, so far, it is unregulated. On the other hand, with some adaptation, this can help fill the financing gap of companies at a time when cash flow is tight. Banks in Malta are becoming more risk-averse now that ECB in Frankfurt assumed oversight of EU banks, and increasingly they only lend against collateral; this is a dilemma since not all budding entrepreneurs inherit property or have rich uncles with fat cheques.

This begs the question – what are the opportunities and risks and can it protect contributors and lenders? During an economic slowdown when GDP growth is weak, it stands to reason that starting up a company takes one on a very risky and challenging journey. Besides finding sufficient funding, there are always expenses that are impossible to forecast, challenges to make realistic market projections, assessing correctly customer preferences, and last but not least fight competition from peers. Consultants come expensive and it is not unheard of that unscrupulous ones hiding under the pretext of helping would want a larger share of your venture. Yet, embarking on a crowdfunding campaign hedges these risks and serves as a valuable learning experience.

In Europe, the Commission, DG Internal Market and Services recently organised a workshop to explore opportunities related to crowdfunding. By having a crowdfunding campaign, the entrepreneur enjoys another advantage, that is the ability to engage the crowd and receive comments, feedback, and ideas which are extremely valuable, as it can help them better understand intricate aspects of their business and could also potentially inspire some other ideas or modify existing ones to better match customer demand. Ordinary investors who agree to the plan tend to own it and will closely follow it through the slippery nursery slopes of early development.

For instance, successful merchandising ventures financed through crowdfunding are blessed with investor loyalty throughout the gestation period of the project when branding is slowly but surely taking place. By comparison, small loans are not favoured by high street banks which consider them risky and high cost so they politely refuse applications or make impossible demands (like heavy collateral or high risk premium). Typically, banks request due diligence, a threeyear business plan (after a SWOT and PEST analysis ), schedule multiple interviews, and then if the bank manager is interested he/she will request more time to filter the figures through specialised software, and finally, if successful, the applicant receives a draft sanction letter loaded with conditions/charges.

Compare this lengthy ordeal with a simplified online process of crowdfunding where under normal circumstances one has to submit online application to an appropriate platform, which then conducts vetting/due diligence work. If accepted by platform, it creates an online profile, launch your online investment campaign, review all interested investors and choose the best fit. Should it prove to be successful, it proudly invites you to collect the funds. What are the costs for such a process? On all or nothing platforms (meaning that you only get the funds raised if you reach 100 per cent or more of your funding target) there is no fee to participate. If an entrepreneur sets a target and doesn’t reach it, the funds are returned to each contributor, and no fee is charged by platform. On the other hand, if the fund-raising project is successful, the average commission for the platforms is a time fee based on total funds raised.

This novel system speeds up the registration of potential business angels to come on board as accredited investors with the crowdfunding platform. Once approved as an investor, one can directly go in and search the Internet platform for different companies, do fundamental analysis on the documentation and investor summaries thereby cutting out all the initial phone conversations and meetings. In fact, many investors can simply identify a company they are interested in and make an investment directly, right then and there. What used to involve a series of meetings, phone calls, and lengthy consultation periods, not to mention expensive legal advice, it can now prove to be a seamless transaction with a faster response.

Crowdfunding in the USA is becoming more popular, particularly in the wake of banks being closely monitored by strict rules, so it stands to reason that it is a welcome alternative. To get started on the path to funding and exposure, an entrepreneur first needs to contact the chosen crowdfunding platform that best suits his her campaign theme and purpose, share the venture’s powerful message, then proceed to create a marketing video, and list attractive/unique selling points of the business. In essence, crowdfunding is an innovative way for entrepreneurs to access finance and the exposure they need to grow. What started out as a social experiment in USA several years ago has proved to be a viable tool for thousands of people, as can be evidenced by a lending book reaching over $1.5 billion giving birth to ventures at all stages. According to the media, seed capital raised in the US via the Small Business Administration has dropped by as much as 20 per cent while nearly 98 per cent of the business plans received by accredited investors and venture capital firms are rejected.

Having praised the crowdfunding novelty, can one ignore mentioning its faults? Certainly not. It is a relatively new phenomenon and a technique successfully employed by not-for-profit and creative individuals/organizations, but it is not a panacea for every business model and its detractors do not consider it as a sustainable source of revenue, because it about a process involving collection of money and soliciting investments, Its critics say that investors expect steady returns and may not be patient if a start-up company does not generate profits during its formative years, which invariably lead to lawsuits regarding failed business and, in such cases, it is common for lenders to accuse the entrepreneur of fraud, over trading, breach of contract or mismanagement.

To conclude, if you are a fish in a small bowl and wish to migrate to a larger one, make sure that you have enough strength to survive the ordeal... but once successful, congratulate yourself on being able to swim in a sea full of opportunities.