The Big Boys Say Crowdfunding is a Drop in the Ocean: And They’re Right

Crowdfunding ­is ‘hot & happening’. So ‘hot & happening’ in fact, that a lot of valid criticism, however badly formulated at times, is discarded. One of the points made that is taken as an outright insult, is the mention that “Crowdfunding is just a drop in the ocean” in terms of funding. Often heard from larger investors, VC’s, banks and traditional funders, this comment is denounced as treason. But in an industry that continually promotes itself the new (and only) way of funding by boasting about growth percentages of 400%, it’s time to come back down to earth and see what truth there is in the comments experienced financial experts have.

The amounts funded are tiny

British Pounds Money £10

This statement is not to be confused with ‘you have small dick’, though judging by the responses, it’s often interpreted like that. The average investments raised during crowdfunding campaigns are usually smaller amounts than the traditional approach.  If you review recent data just published from Nesta in the UK, their report indicates an impressive 201% growth year over year for total volume in 2014.  That type of number makes one stop to wonder but when you compare the aggregate capital raised, Nesta shows £84 million in total with an average amount raised per deal standing at £199,000.  Compare this number from a recent report byBeauhurst depicting a booming private placement market in the UK.  Inclusive of crowdfunding through Q3 of 2014 capital raised totals £1.62 billion with a quarter remaining.  This means that equity crowdfunding amounts to little over 6% of total funding – a mere drop in the bucket.

According to at least one data source the average funding for all Title II, 506(c) offerings in the US since inception has been approximately $405,000.00.  The total funding amount up to this past September is not small coming in at over $385 million.  These aforementioned numbers attempt to align with small and emerging companies but if you add back real estate and other areas, this number will certainly rise.  According to a report compiled by DERA, the research arm of the SEC, total Reg D private placements hit almost $1 trillion in 2012 alone.  Again in contrast the amount that is transacted online via crowdfunding is small in comparison to the potential addressable market.

Wall Street Metro Station Downtown Brooklyn

So are the ‘big boys’ right if they say that crowdfunding is a drop in an ocean? Yes they are. Does that mean that crowdfunding isn’t important? Of course not. For example, in 2013 over 1250 companies got funding via 29 crowdfunding platforms in the Netherlands.  The UK had 44 platforms in 2012, the US had 191 platforms. Of course you can’t extrapolate the data directly, but it’s a great indication of the amount of companies that are being started and the jobs they create. The fact that ‘normal’ people are willing to spend money is also encouraging in terms of economy.

Crowdfunding is for social companies only

Another less well documented idea hovering around is that crowdfunding is for social projects or companies mostly or only. Because crowdfunding projects, especially in rewards based and donations crowdfunding, tend to do better when there’s a higher meaning behind it. Yet the semantics of the deliberation show that there’s a tendency to discard crowdfunding as a ‘soft’ way to fund a company. And that if a company isn’t fully commercial, it’s not benefitting the economy.

That notion is nonsense. On the one hand I agree that attracting an intrinsically involved group of crowdfunders will lead to a more dedicated and interested group of ambassadors, which is logical. But the idea that social or sustainable companies don’t benefit the economy and are therefore not worth funding is ridiculous. It would mean that Greenpeace doesn’t provide jobs as well as a commercial company, or that it pays less for other company’s services.

On top of that, lending seems to defy the notion that social or sustainable companies aren’t worth funding very strongly. If we look at what gets funded most quickly and raises that highest amount of money, it’s the project or company that offers the lowest risk for the highest interest rate. Be it a commercial, sustainable, social, ‘green’ or any other type of company: money is money. And no matter how much we say crowdfunding is about ambassadors, ideals and involvement, if you don’t get the money your campaign has failed.

Crowdfunding:  the end of banking as we know it

Royal Bank of Canada Toronto

Tony Greenham is a well-established financial expert that has spent quite some getting to know crowdfunding. And when he wrote “Crowdfunding: the end of banks as we know it” on the New Economics Foundation blog, he was clearly expressing a wish for betterment within the financial industry, a sentiment that is much reflected in the industry.

But ‘the end of banks as we know it’ isn’t anywhere near. There are some elements that need decent adjustments, but banks won’t disappear nor will they radically be forced to adopt a smaller position. “They’re to big to fail”. Crowdfunding has been here for about 4-5 functional years, depending on what source you turn to. The pillars of the financial system won’t be able to change in that little time, even if they wanted to.

Then what will happen to the banks? They will mainly change their roles. The idea that crowdfunding is cannibalizing on their incomes is ridiculous, even taking into account “the large potential” (a tell-tale sign that’ll ring the alarm of any experienced investor) of crowdfunding. The part that crowdfunding is currently picking up, is only a tiny piece of funds that banks or VC’s wouldn’t have provided in anyway. Most banks can’t service the larger part of entrepreneurs knocking at their door, so it really doesn’t matter if platforms take a share in that funding part. The only direct threat as described by Capgemini’s Patsy Neville, which is still very small, comes from the side of investors who’d rather get interest on their crowdfunding investment than on their savings because the latter is hardly anything.international money europe euros

Of course, this is from an environment (Europe) that geared towards banks providing loans and not having (well enough developed) services for investors, whom as a result, finally have a decent alternative. Conclusion is that crowdfunding in terms of money processed is not even close to what is being processed in established financial markets. But a lot of entrepreneurs ánd investors think crowdfunding is a much friendlier way to raise money than going to a bank. In the future a hybrid funding structure will be developed, continuing the interplay between traditional funders and crowdfunding.

How can we leverage the potential of the crowdfunding market? 

Because the equity crowdfunding market isn’t there yet, it doesn’t mean it’ll never get there. The two main strategies that could be used to unlock the (U.S.) crowd investing market, are less strict requirements for (accredited) investor or a more powerful Regulation A+.

Accredited Investor Qualifcations featured

With regard to the firsts change, the rules for accredited investors may be eased up, as clearlyexplained by Anthony Zeoli. One option that has been heavily discussed is measuring the suitability of an investor by the extent of his knowledge, not his wallet. Though the arguments are valid the implementation of a structure that would support this is hard. As a result, the other option that could be used, is making use of a more vibrant Regulation A+ – another tenant of the JOBS Act with final regulations still outstanding.

What does this mean in terms of capital? That the crowdfunding market could share in the almost $1 trillion investment market that is currently in existence through Regulation D

Tarte tatin pie food

From 2009 to 2012, non-financial issuers (typically private companies and not PE, VCs Funds, Hedge Funds etc.) raised $354 billion. Hedge funds were in first place raising $1.2 trillion.  Yet at the same time (during the same period) the number of non-financial issuers stood at over 40,000 dwarfing all others in this regard.  It is this segment that investment crowdfunding has great potential to not only share the pie but grow it even more.

It is understandable that legislation and regulations may take some time. But excluding a segment of society due to their money in the bank as opposed to the ability they possess just seems rather wrong.  It would seem there’s reason enough to update legislation for the better. Though it’s hard to say something about the exact timing of the implementation of new regulation, it’s sure that when it’s being activated, the equity crowdfunding market will benefit most.

This article has previously been posted on CrowdfundInsider

Convertible Loans as a Band-Aid Solution to the Valuation Problem in Equity Crowdfunding

What’s happening: the industry wants equity

It’s ironic that crowdfunding makes it possible to set up companies that otherwise never would’ve come into existence, only to ruin them later by postponing the valuation issues that any start up will have to solve sooner or later. Might the positive start of crowdfunding come to a halt due to unsavoury developments, convertible Crowd Fans Audience Trafficloans specifically, within the equity-crowdfunding branch?

The good news first: crowdfunding continues to grow, especially equity crowdfunding is catching up. From the beginning of this year, equity crowdfunding has seen a delayed but sharp increase compared to the other forms of crowdfunding (donations, rewards, loans). A development that is projected to continue along with the funding volumes in this niche. The fact that (somewhat) complicated capital forms are being adopted means that entrepreneurs and investors are ‘reading up’ and that the industry is maturing. Reason for some platforms take their chances and claim they’re offering equity crowdfunding: without solving the valuation issue.

The sweet and sour of equity crowdfunding

During the last decades, Europe has been heavily hooked on bank loans much like the U.S. was in the ‘80’s. Since the financial downturn (and now its projected upturn) entrepreneurs have had to develop some creative financial income streams, one of them being crowdfunding.

Equity vs DebtEquity crowdfunding is a specific type of income generation that a lot of people have never learnt to control or deal with sufficiently. They’re simply not educated in this field, which explains why peer-to-peer lending has seen a major increase in the beginning of the crowdfunding era whereas equity has been a slow starter: people don’t understand so people don’t use it.

Now that equity is increasingly being adopted by investors and entrepreneurs, more platforms are eager to claim that they offer equity-crowdfunding. But the problem they run into is valuation. It’s hard to valuate a company that (often) hardly exists. And in contrary to traditional entrepreneur- investor settings, there is no discussion on how much a company is worth because.

The crowd often receives a certain valuation as a ‘take-it-or-leave-it’-offer, and investing means you agree with the valuation. Some platforms like CrowdCube offer the opportunity to ask for a “Alternative Offer” but 99% of the equity platforms isn’t that well developed. On top of that, even when the crowd does discuss a company’s worth, they often lack the knowledge to create a factual, calculated value.

So what do platforms like ReturnOnChange, Fundable, Seedrs or the Dutch platform Wekomenerwel (“We’ll-get-there”) do: they offer convertible debt as a way to delay the valuation issue.

Why are convertible loans bad for the crowdfunding industry?

Mark Suster, a two-times entrepreneur turned VC, has written extensively about the pros and cons of convertible debt in the traditional setting (not crowdfunding), explaining the difficulties in this form of equity instrument.

For those not informed, a convertible loan is a loan you get from a (potentially) future investor with oftentimes a very low interest rate, because the creditor belies that at a later stage he’ll be able to acquire part of the company for a relatively low price.

What’s so great about convertible loans?

If you don’t know exactly how equity investing works or what it might mean for your company (which unfortunately is the case more than we’d all like to admit) let alone cracking your head over a reasonable valuation, convertible loans sound pretty good. It’s a loan against fairly low interest rates. And when the creditor in a later stage becomes shareholder, he often doesn’t own voting rights.

The only catch: you don’t know what price you’re selling your company for, you’ll decide that later. I understand that in specific cases a convertible debt seems a good decision to make, especially for start-ups who often can’t (or don’t want to) spend a lot of time and money on the legal requirements of setting up the entry of a (direct) investor in the company (which is an invalid point in equity crowdfunding if you have the right legal structure). But in comparison you’d never agree to buy a car, put down a certain amount of money on forehand and find out later that you should’ve paid much less considering the milage. You’d run the risk of a scam.

Within the crowdfunding industry the tendency has arisen to do exactly that: expose your company to bad deal. The risks include not being able to pay back the loan or develop crucial parts of your company because you have a loan, unreasonable and/or unnecessary dilution and even losing control of the company. And all because we don’t want bust our balls over a valuation.Discounted Cash Flow Valuation Firm Value

Valuation is unfamiliar, complicated and expensive and it belongs in the financial department according to many starting entrepreneurs, not in the product/marketing department of which most start-ups are made up of. That still doesn’t mean taking up a loan now and hoping for the best (which is what convertible loans often seem to come down to), is how we should develop equity-crowdfunding. Convertible loans in the crowdfunding area are used as an excuse to delay the valuation problem: not to solve it.

The answer to the valuation problem? Do a valuation.

Which is very strange, considering a solution is already at hand. There are several alternatives at hand besides going to your accountant.

One example is EquityNet’s Calculator, extensively described in this article, which aims to create a quick scan valuation allowing the entrepreneur to have valuation within a few minutes straight into your e-mail inbox.

Stack of Coins MoneyAnother example that was started as a side project by SmartAsset, is Startup Economics. Though the tool is great for getting insight in the relation between raised funding amounts and share prices, for starting entrepreneurs it might be a little too much too soon, asking questions “the maximum pre-money valuation at which the notes may convert into equity”. It’s great to ‘play’ around with the figures and see the immediate feedback so that you can quickly get a grip on what is what in terms of numbers.

Another option is Equidam which has developed an entire company around online valuation. You won’t be done in two minutes, but based on a combination of your quantitative and qualitative input and five valuation methods; you’ll receive a 20-page report (paid) or the first free pages including your valuation for free.

These might not be the only solutions, but for now, they’re the best online start-up valuation methods I’ve seen. It offers an objective basis for supporting you valuation and for a lot of entrepreneurs (if the data is realistic) it’s a wake-up call as well as a good bottom-line for the valuation discussion. The DCF with DG, DF with multiples, Scorecard Method, Checklist Method and the VC method are all included and the report covers 20 pages of data and explanation to back up the start-up’s value.

Like I’ve argued before, the crowdfunding field can learn a lot of things from the traditional capital markets, with convertible loans as a beautiful example. Crowdfunding platforms should take responsibility for the products they help to sell and actively work towards a qualitative solution for valuation instead of adopting a ‘head-in-the-sand’-attitude. Instead of polluting the feeble and merely developed crowdfunding market with exotic investment vehicles that often don’t work in a traditional setting either, let’s focus on creating a real solution: a decent valuation method for start-ups.

Editors Note:  Symbid holds a small equity position in Equidam

This article was previously published on CrowdfundInsider

The Real Difference Between VC and Crowdfunding? Investment Marketing

A few weeks back the value of VC’s for the crowdfunding industry was extensively discussed. Why? Because there are lot of areas where crowdfunding and VC’s can connect. And though traditional funding and alternative funding are not as rigorously separated as many want to believe, there are some inherit differences that characterise crowdfunding as a different form of funding.

Tanya Prive in 2012 wrote an article on Forbes describing crowdfunding as “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.”. Rachel Chalmers refers to as VC money as “fuel for hypergrowth”. In addition, VC’s are in the business of making money for their own investors. Besides the target audience (crowd vs. VC) there doesn’t seem to be clear difference if we look at equity crowdfunding.

In both cases the investor profits financially, entrepreneurs are requested to deliver certain information and investors need to be convinced. Then why worry about the differences? Because, despite being marketed as the go-to Holy Grail of funding, most crowdfunding campaigns fail, only 1 in 10 succeeds on IndieGoGo (according to The Verge’s great article). And not because they were all bad investment opportunities. The problem was marketing.

Timing of the money

A first, very well visualised differenced can be found via Startup Guide: the timing. As you’ll see the type of funding for each phase varies a lot. Of course there’s some overlap but in general, VC’s won’t invest in anything that isn’t creating revenue yet. Crowdfunding on the other hand, has the reputation to be solely for start-ups. In my everyday job as Symbid‘s proposition manager where I coach the entrepreneurs in their funding, I see very different companies.

Small companies that have been in existence for quite a time (between 5-25 years); film funds that have a million dollar budget but want to do some form of inspiring marketing; individual entrepreneurs who still have to write down their business plan; growing start-ups that come back every year for another round and companies want fast forward their growth, using the money for “hypergrowth”.

Because crowdfunding lets the entrepreneur be in control of their own funding trajectory, it can be used any time they feel the time is right. Of course there are some exceptions (if you have no time for it, then don’t do it), but it is the entrepreneur that is fully responsible for the how and when of the funding process.

The reputation and differences in outcome

Crowdfunding was the first aid kit for capital when no one else will give you money. Crowdfunding is a necessary evil, having a VC is a luxury. But is that true?

Chalmers gives five very compelling reasons why you’d want to stay away from Venture Capitalists as an entrepreneur. In summary, a loss of control and narrowing down business development options. The idea that most successful companies raise money via a VC is a urban legend in Entrepreneurship Town; lots of companies succeed without that money.

Again, via crowdfunding the entrepreneur stays in control for the most part. Though a good VC investment can bring lots of good for a company, the company is a product that the VC needs to make money in. While in crowdfunding, there’s a sense of togetherness, sharing and support backed by money. Different ways of funding your company that have different results and different outcomes for you company. And with all the sustainable, social and consumers as “fans”, one might start to think equity crowdfunding is starting to become the epitome of involving your customer.

Self regulated fund raising as a basis for the process & dynamics

Entrepreneurs prepare a campaign when starting with crowdfunding, instead of a single pitch that appeals to all VC’s alike. This also means “one at a time” vs. a full blown marketing crusade: that’s a VC funding quest vs. a crowdfunding process. Whereas getting the right network and subscriptions to VC-networks gets the entrepreneur one appointment at a time, crowdfunding requires to think about ways to reach your audiences and target markets as successfully as possible.

Questions like: what am I selling to whom, who is my target audience, is my own network a seperate group, is there a difference between my customers and investors, where are they, how should I address them, should we send out a press release, and so forth are not at all uncommon during crowdfunding. Whereas a entrepreneur wouldn’t send out a press release about his appointment with a VC, nor would he continuously (almost obsessively) update his network about the progress.

Though the information used as a basis of communication (business plan, financial projections, etc.) is often the same, the ideas and literal message are very different. If an entrepreneur decides to root for VC, their business will be tailored for a specific payback. In crowdfunding, the campaign in itself, a small ROI and the opportunity to make something possible, are the expected outcomes.

Instead convincing the VC’s the entrepreneur engages; instead of saying “your investment makes ABC possible” and entrepreneur has to focus on “together we can..”; instead of talking to a superior or someone the entrepreneur is dependent on, they’ll talk to their peers. Crowdfunding is weeks of continued marketing efforts in order to gather funds bit by bit, while VC money are intermittent,  singular conversations that aim to get a large amount of money at once. These differences highlight the difference between the characterizing dynamics for each type of funding.

Investment marketing

In short, whereas VC’s money is hauled in by “closing the deal” and single selling moments, crowdfunding really is investment marketing. If we look at the dynamics during the campaign I could swap “the company” for any other product and it wouldn’t be called “crowdfunding” but “marketing”. Analysing and setting up various campaigns, the 4 (or 7) P’s are a great way to make entrepreneurs think about what they’re selling and how they’re attracting enough customers, emphasizing the strong marketing dynamics that really separate crowdfunding from VC funding raising.

 

McKinsey says ‘Business Needs More Women’: Crowdfunding Can Support This Goal

Why do we want more women in business? Practicing gender equality is usually not the reason one starts a company. Are men making a mess of our economies and companies? Is “the men’s world” not functioning or failing in creating sustainable growth within our economies? No, not really. The vast majority of men in companies are good people and devoted individuals. By no means are men the ‘wrong-doers’ and should be replaced because of such a (faulty) reason.Then why does this discussion matter?

Women make companies perform better

Numbers don’t lie, especially not when they’re provided by McKinsey & Company: companies with some 30% or more women in top level functions, perform better. A lot better actually, according to McKinsey & Company’s yearly report “Women Matter”. These companies have better return on equity, 11.4% vs. companies who have significant lower amounts of women in their top layer of the company. In addition, operating results are better (11.1% vs. 5.8%) and stock price growth is also significantly better (64% vs. 47%). Women like Marissa Mayer and Sheryl Sandberg are examples of what women could potentially contribute to a company.

In addition, in 2040 Europe is expected to need another 24 million people to tackle the workload, and women are already there. Another reason why we need more women on the work floor is that they’re usually the main decision unit in household purchases, and I’m not talking about groceries. Women spend 71% of the household budget. In Japan, 60% of the women are responsible for choosing a car (now there’s a man’s-world industry for you) and in Europe 47% of the PC’s are bought by women. Notice the “glam” redesigned notebooks that are now available? Notice the advertisers bragging about low weight PC’s? You know why. Then why is it that, according to the Boston Globe, a company pitched by men is 40% more likely to receive funding? And how can crowdfunding change that?

It’s Partially Women’s Own Fault

A lot of women simply approach things differently. If you ask women why a project was successful, about 70% will tell you they were lucky, they worked hard, etc. Men will tell you they’re awesome, says research. In addition, women tend to not discuss their success and attribute it to others (the team). Costa Rica’s first female president, Laura Chinchilla says women are seen as weak because of this: “We understand success not as the result of just one person but as the result of a team,” she told Forbes’ writer Jenna Goudrau. “[It’s a] different way of dealing with power [that] is misunderstood as a kind of weakness.”.

On top of that, women deal with “double trouble”. First, it’s difficult to what Sandberg (and McKinsey & Company) to the “double workload”: raising a family and developing your career. Reports show that in the case were equal companies pitched by either a man or a woman, the man was more likely to receive funding. The reason? Maybe a story sounds more familiar to man when it’s told to him by another man, we don’t like what’s unfamiliar. Much the same way society might prefer a female child care taker instead of male childcare worker, a.k.a. “Manny”..

The Solution is Part of the Problem

If we want more women in business, what’s stopping us? Well, the women are actually. They stick together in Women’s Clubs, Women’s Awards, etc. Personally, if someone ever handed me the award for “Best company with a female CEO”, I’m not sure I’d appreciate it: “Here’s your consolidation prize, now go play with the other kids”, or, “You’re not bad at all.. for a woman”. It sucks to be considered a second rank “leader”, or cheerleader, as was Sarah Palin.

Then why do women do this? Because men do it too. The (in)famous “old boys network” didn’t spontaneously come into existence. Men-only business and networking clubs (as insightfully described by The Guardian)  have existed for over hundred years, plenty of time to establish the beginning of the just as infamous glass ceiling. And even though “Women-only clubs” aren’t going to completely solve the problem, I can definitely imagine that it’s easier to pack some punch when somebody has your back. And why desperately try to build that back up framework with a group of people that need some serious convincing (men), when you have another group of people that is very willing and open to support you: women. And though I have some serious doubts about this form of separatism, there is one specific area in business where women might actually help each other conquer the business: online investing.

Women Investing in Women: online

In order to get more women in (offline) businesses we need to activate women to pick up projects or start up companies. Tough when you’re faced with the barriers above but much easier when you create an environment where those barriers are minimized. Women have the tendency to fund a larger part of their company themselves as it’s harder for them to come by via men, according to USA Today. The result? A company that has fewer resources to fully develop its potential. The solution? Ask a woman to crowdfund the initiative instead of raising funds in the traditional way.

First, the chances of raising funds via a lot better. 42% of Indiegogo’s successful projects are run by women, says Geri Stengel’s Forbes contributor. These crowdfunding campaigns are often mostly funded by other women, according to. They also raise some 11% more money than men, and according to USA Today, women make better investors because: 1) they focus on long-term, non-monetary goals; 2) they are less prone to take unnecessary risks and do quality research; and 3) that men trade 45% more than women, leading to a loss of 2.65% on men’s net returns. And women lead campaigns get 1.3 more followers than men lead companies, according to CrowdExpert.

How does crowdfunding success get more women in business?

Women get a fair chance. No (or less) bias, more access to more investors, both men and women that, in contrary to the established funding industry, are willing to take chance in a woman lead company. There is more money flowing in women’s initiatives, giving women the chance to prove their potential. In establishing great cases, more women like Sandberg and Mayer earn a place in the spotlight, increasing the society broad idea that women can actually achieve something. That way, more and more people (men and women) get the live demonstration of what already has been proven: women make business better.

Final note of the authorI’ve never been much of “we need more women”-person. I believe in hiring the best and if that’s not a woman, I’m fine with that. As a result I was totally unaware of the fact that companies with a certain amount of women perform better, before writing this article. In addition, doing my research for this article I’ve noticed this discussion is very extensive (and quite interesting really) and I haven’t addressed all the related points on purpose. If you have any subjects you’d like to touch, feel free to share them in the comments.