Everything micro-SMEs need to know about crowdfunding We take care of business 1 Contents Foreword Page 3 Introduction Page 4 What is crowdfunding? Page 5 The size of the crowdfunding market Page 6 How is crowdfunding different to other ways of accessing funds Page 7 Types of crowdfunding Page 8 Advantages and disadvantages of crowdfunding Page 10 What are crowdfunding platforms? Page 11 What are the risks of crowdfunding for businesses? Page 13 Is crowdfunding regulated in the UK? Page 14 How to make crowdfunding work for your business Page 15 If you’re thinking about investing Page 16 Thank you to all our contributors Page 17 Everything micro-SMEs need to know about crowdfunding. 2 Everything micro-SMEs need to know about crowdfunding. Foreword One of the vital ingredients to running a successful business is effectively managing its finances. Achieving this isn’t just about cutting costs. Businesses also have to know where to spend money to function and invest it to grow. But insufficiency of funds from within small businesses, particularly those with less than 10 employees, can be restrictive. “Looking beyond just the traditional means of funding is becoming much more popular to small business owners and crowdfunding has captured the headlines like no other type of alternative funding so far. We think that access to information that help business owners fully understand crowdfunding and decide if it’s right for them before they start investing in the process is essential”, comments Ibi Moghraby, Managing Director at Premierline, one of the UK’s leading providers of small business insurance. This Crowdfunding guide aims to help micro-SMEs make an informed decision about whether or not it’s the right source of finance for them, how to maximise success and provides direction to resources to help make this work. Everything micro-SMEs need to know about crowdfunding. 3 Everything micro-SMEs need to know about crowdfunding. In 2013, 95% of UK businesses employed less than 10 people1. That’s 4.7 million micro-businesses vying for space to grow in a persistently tough economic environment. Until the banks release the tight grip on their reserves, micro-SMEs sometimes have to seek alternative forms of funding to overdrafts and bank loans. Crowdfunding is becoming more popular for many. 95% of UK Crowdfunding is a way of raising money from lots of people via a website. businesses Businesses with a good idea pitch their project online and offer rewards or financial returns for people that pledge or invest money. employ less than However there’s a lot more to crowdfunding than just raising funds. It’s a great way of building a community of followers, engaging with a target 10 people audience and establishing long term relationships with those who will support the business into its future. Many of us have perhaps heard about crowdfunding for business. But start-ups and micro-SMEs that are considering using it to raise funds need to fully understand it before diving in. That way they are more likely to reap the rewards they’re after. 1 www.parliament.uk/briefing-papers/sn06152.pdf Everything micro-SMEs need to know about crowdfunding. 4 Everything micro-SMEs need to know about crowdfunding. What is crowdfunding? Let’s start with a crowdfunding definition. Crowdfunding is a way for businesses or projects to raise money by inviting lots of people to pledge or invest small amounts, usually online. It’s a form of alternative finance, which means that it doesn’t involve traditional banks. Generally businesses advertise their project on a crowdfunding website and potential investors choose whether to pledge money, how much, and the return (if any) they expect. So when did crowdfunding begin? Modern crowdfunding started life in the UK, when rock band Marillion asked its fans to fund its US tour in 1997. From then on it gradually grew, before erupting into British lives in 2009 when it became a significant, plausible choice for people wanting to finance their ideas. “Crowdfunding is a very broad term covering very There are three types of crowdfunding: different models from the lending model where you get a loan from the Reward Crowdfunding - crowd which you have to this relies on contributions from investors for intangible or repay with interest, to non-monetary reward reward based models where your backers prepurchase the product you are making.” Liam Collins, Debt Crowdfunding - Nesta the crowd donate to your business or project in exchange for financial return and/or interest at a future date Equity Crowdfunding - investors receive a stake or shares in the company in return for their investment Everything micro-SMEs need to know about crowdfunding. 5 Everything micro-SMEs need to know about crowdfunding. The size of the crowdfunding market Since the beginning of 2014, businesses have been raising £1,700 per hour2 through crowdfunding, which is a form of alternative finance (because no banks are involved). The alternative finance market as a whole is growing at an astonishing rate in the UK and is predicted to be worth over £1.5bn3. Some businesses are basing their entire growth on crowdfunding. Global records of $40m have been raised through US crowdfunding websites like Kickstarter and Indiegogo. The craze is embedded in the UK too, with the Bristol Park and Slide and the Arran Brewery both hitting the headlines because of the support they have gathered through crowdfunding. Even though crowdfunding gets comparably high volumes of media coverage, alternative finance is still a relatively small market compared to traditional bank lending (which totalled some £7bn4 for SMEs in Q3 2013 alone). In fact, only 5,000 UK SMEs raised funding through the alternative finance market between 2011 and 20135. Nevertheless it’s growing at an astonishing rate, with the UK market growing at 350% in February and March 20146. Crowdfunding is taking off in the UK for a variety of reasons, the most popular being lack of available funding from banks. So with the rise of social media it makes sense that businesses are turning to their networks to raise money instead7. 2 http://www.businesszone.co.uk/topic/finances/entrepreneurs-raise-1700-hour-through-crowdfunding/55927 3 http://www.nesta.org.uk/media_colorbox/2279/media_original/en 4 http://british-business-bank.co.uk/ 5 http://www.nesta.org.uk/publications/rise-future-finance 6 http://thecrowdfundingcentre.com/?page=datacenter 7 http://www.theguardian.com/business/2014/jan/21/small-business-funding-bank-of-england http://www.biz-works.net/index.php5?SID&fl=y&pgid=bp&art=474&st=banks-turn-away-over-half-of-smes Everything micro-SMEs need to know about crowdfunding. 6 “Banks will continue Everything micro-SMEs to be a vital source of need to know about finance but it’s not a crowdfunding. one-size-fits-all solution, and we’re encouraging growing firms to open their eyes to the broad How is crowdfunding different to range of funding options on the market.” other ways of accessing funds? Traditionally if a small business wanted money its only option was to report CBI to its bank manager with a business plan and request the funds. Thankfully times have changed and there are now several ways to access capital, of which crowdfunding is one. Other than bank loans, overdrafts and credit cards, the main sources of finance for smaller businesses in the UK8 are: l Trade credit: suppliers allowing their customers to buy now and pay later l Asset backed finance: lending that is secured by an asset, which is taken if the loan is not repaid “Beware that responding to requests and l Invoice discounting: a third party buys sales invoices for a fee comments from the l Angel investment: affluent individuals or groups provide capital in return hundreds (and in some for debt interest or equity shares cases 1,000+) [of] backers of your campaign l Venture capital: funds, guidance and reputation are given to rapid-growth is very different from businesses in return for ownership positions or high interest rates (or both) managing one or two The major difference between these forms of finance and crowdfunding is traditional funders and the number of individuals or institutions involved. All of the above depend on will require quite a lot of one or just a few contributors, where as crowdfunding relies on many small time and effort.” investments from lots of people. This can result in significant amounts of time and effort being spent engaging with investors. Peter Baeck, Deciding which type of finance is right for a business is, therefore, far from Nesta simple. However, 57% of small and medium-sized firms spend less than an hour researching according to the CBI9 finance providers. The CBI has therefore launched FindmyFinance, an online tool that helps businesses identify the types of alternative funding that are suitable for their needs. 8 http://british-business-bank.co.uk/performance/facts-and-figures/ 9 http://www.cbi.org.uk/media-centre/press-releases/2014/02/we-need-to-shatter-the-equity-finance-glass-ceiling/ Everything micro-SMEs need to know about crowdfunding. 7 Everything micro-SMEs “Irrespective of the need to know about type of crowdfunding model, it is key to provide crowdfunding. a compelling proposition in order to be relevant in the current market.” Types of crowdfunding Julia Groves, Crowdfunding has three hats depending on the needs of the business or Trillion Fund project and the motivations and expectations of the potential investors. Reward crowdfunding (sometimes called donation crowdfunding) relies on people’s contributions to projects or causes for often intangible or no return. Depending on the situation, investors might get an acknowledgement in a book or free entry to an event, but their real motivations are usually to support a good cause or to feel bought in to something in their community.