Turning to the crowd

Securing finance and funding is one of the most critical issues for small businesses in Australia

by | 17 Dec, 2015

Turning to the crowd

As detailed in the recently released Australian Small Business White Paper, produced by the IPA Deakin University SME Research Partnership, securing finance and funding is one of the most critical issues for small businesses in Australia.

In particular, the Small Business White Paper highlighted funding problems faced by young firms in uncertain technological or new knowledge environments – because of their unattractiveness to bank lenders.

With this in mind, the White Paper suggested crowdfunding as a novel method for financing a variety of new ventures. While still a very young sector in Australia, crowdfunding has already proven to be an effective funding platform for new business in other markets. Crowdfunding allows individual founders of for-profit, cultural or social projects to request funding from many individuals, either in return for future products, equity, debt or donations.

Projects differ greatly in both goals and magnitude, from small artistic projects to entrepreneurs seeking hundreds of thousands of dollars in seed capital as an alternative to traditional venture capital investment.

Perhaps in response to the variety of projects seeking finance, a number of different types of crowdfunding have emerged both here and in other markets globally. A recent report classified the individuals by type of funding and motivation – see Table 1 below. Currently in Australia both crowdfunding lending and equity crowdfunding are restricted to receiving investment from sophisticated investors only, however, there is widespread hope around the crowdfunding community that this will soon change.

From a policymaker’s perspective, two issues dominate the contemporary regulatory discussion: How do we encourage a major new activity that directly addresses the financing of entrepreneurial activity? While at the same time, how do we stop this new activity being a licence for fraudsters and grafters to prey on the vulnerable and the gullible?

Given crowdfunding’s relative immaturity, the Small Business White Paper describes the current

situation around crowdfunding as follows: “The reality is that we are all in unknown territory with this novel, exciting and potentially scary form of entrepreneurial finance. The remainder of the decade will be a very steep learning curve as to crowdfunding’s strengths and weaknesses.”

The crowd as it stands

Both donation and rewards-based crowdfunding have already taken off in Australia and a number of platforms are currently helping projects and businesses to get off the ground.

As of 8 November 2015 crowdfunding platform Pozible had launched 10,343 projects with a 57 per cent success rate. As an ‘all or nothing’ platform, Pozible projects must have a clear funding goal and a time limit within which the funds must be raised. If the project doesn’t reach the target amount within the time limit, no money changes hands. To date AU$41,247,770 raised in pledges has been paid.

While Pozible calls itself a rewards-based crowdfunding platform and tries to avoid donation-based campaigns, one in three people contributing across across the site actually choose to receive no reward. This, according to Claire Merquita, general manager at Pozible, is a good re flection of the mentality of those currently involved in the crowdfunding space in Australia. It shows, she says, the community spirit intertwined in crowdfunding right now, which is also re flected in the types of projects that receive the

best support.

“Our strongest categories have always been from the creative industries, film, music, performance, theatre, that sort of thing,” Ms Merquita says.

The law of the land

Currently, most projects receive a large proportion of funding from the creator’s own network of family and friends, something that Ms Merquita says helps to self regulate the industry.

“The first people that support a crowdfunding campaign are always your friends and your family, so if you’re going to run off with their money… there’s not actually many people who would do that,” she says.

As another layer of self regulation, it is common practice for crowdfunding platforms to vet projects before agreeing to host them on their platform (there is another incentive, the widely accepted practice is for platforms to only be paid for successful campaigns).

“We (Pozible) personally approve every project that comes through,” Ms Merquita says. “Someone in the team will take a look at the project and make sure that there is nothing dodgy going on and a lot of projects do get rejected because it doesn’t seem like they would be able to fulfill what they are trying to do.”

Of course, despite this, not all projects run so smoothly and not all project commitments are met.

“What you do see is projects that underestimate, for instance, how much it is actually going to cost to put on that project so they’re not able to achieve everything that they wanted to achieve,” Ms Merquita says.

“Having said that, the failure rate of projects is incredibly low,” she adds. “Less than half of a per cent of all projects would fail, you do see delays more often but generally because we require that projects’ creators keep everybody updated, [so] that kind of relationship doesn’t turn sour, it’s usually fine. It’s going to take two months longer and everybody’s okay with it.”

OzCrowd, another popular platform in Australia, also sees a lot of pledges from personal networks but hopes with updated regulation that may soon change. “I’ve been working with small businesses for a long time and I saw a bit of a need there for an Australian platform to help them out but a lot of the time we tend to get more personal than business causes,” says OzCrowd founder and director Nick Karolidis.

“The best example is when someone’s trying to develop or publish an album they tend to offer fans or friends and family a signed edition of the album.” While Mr Karolidis is proud to help fund so many valuable projects he says he is frustrated he cannot yet help small businesses as much as he would like. Currently limited to donations and rewards based crowdfunding, Mr Karolidis says he wants to see equity based crowdfunding embraced in Australia.

“It would be nice to have that third option because we do have a lot of businesses either have a go

at rewards-based crowdfunding and it doesn’t work for their business because rewards really works if you’ve got a product that you can ship out to a lot of people,” he explains. “If you’ve got a service-driven

business or something a bit more substantial it’s a bit hard to offer rewards in exchange for contributions.”

Treasury has been consulting with a large number of stakeholders in regards to implementing equity crowdfunding in Australia and, according to Mr Karolidis, there is widespread hope an exposure draft will soon be released and the appropriate legislation will soon be tabled. The IPA made an extensive submission on the proposed regulation for equity crowdfunding, which included a comparative analysis of crowdfunding in the UK, EU, US and various other markets.

Equity crowdfunding 

Equity crowdfunding is actually already legal in Australia as long as you only market to wholesale investors, says Jeremy Colless, managing partner of Venture Crowd, an equity crowdfunding platform for sophisticated investors.

“Usually the projects that we are looking for on the equity side, in terms of private companies, are companies that have the potential for high growth, so they’re often technology start-up companies

but also have some perspective on what their exit or liquidity event may be.”

Given these are the companies most in need of finance options, Mr Colless says he would like to see equity crowdfunding opened up to all investors.

And with regards to formal regulation, he thinks the less the better, believing the market will regulate itself in a much more efficient manner.

“We believe unlike rewards based crowdfunding, equity-based crowdfunding is very much reliant on the quality of the companies that go through the platform. We think it’s very important that the crowd isn’t investing in people who haven’t gone through some vetting process,” he says.

“What we do to provide that pre-screening for investors is that we partner with a range of accelerators, incubators, university programs, angel groups, venture capital firms. “We believe that there has to be some sort of pre-screening process to ensure there’s no charlatan or companies that are perhaps not investible.”

Mr Colless says he is worried that when equity crowdfunding is made available to all investors in Australia it may be over-regulated as the government looks to play it safe around consumer protection. Despite the industry itself pre screening as a prerequisite of its own success, Mr Colless fears the government will place an excessive burden on platform providers.

“It’s sometimes hard to legislate because you don’t know what the unintended consequences are and you don’t know how the market will actually grow,” Mr Colless explains.

“My preference would be that the regulation of this sector is as light as possible but at the same time either the operators or government or both really do need to encourage education, do need to encourage approaching a risky asset class with a diversification strategy and assigning capital to this sector [that] is appropriate with the risk reward that you’re targeting as an investor.”

Rewarding success

Offering the right rewards and recognition can make or break a crowdfunding campaign. Despite the fact a large proportion of funding is often raised through personal networks, the majority of backers still want something in return for their support. Given the importance of such offerings, OzCrowd has outlined a few tips in its quick-start guide to crowdfunding:

The product/service/event: for free, at a discount, or as a pre-order. You could combine these incentives if you are looking at tiering contributions.

Early delivery: can you prioritise backers to be the first to get it? See the success of the Pebble watch.

Product/service enhancements: for example, ‘investor editions’, ‘collector editions’, the deluxe version, signed copies, extended period of guarantee or servicing.

Events: special access to get behind the scenes or stage, meet the cast, musicians, artist or celebrity. You might offer merchandise and souvenirs.

Exclusives: you could offer exclusive invitations to the launch or host a private event to thank your backers.

Even a thank you! Consider a public acknowledgement, for example on your website, on or within your product or product packaging. Maybe you could list your backers on the label or on the back of packaging for the first release.

A word of warning

Despite the numerous success stories promoted by the crowdfunding platforms, many campaigns fail to

reach their goal as William Horton, an Australian scientist and founder of AusBiodiesel, can attest to.

We are an Australian company but we have a joint venture in Scotland where we are building a bio fuel plant to make kelp to bioethanol. We hopefully will soon have a joint venture in a part of China and also in New Zealand. We have our own technology and actually have an international patent, which is in the two-stage conversion of algae to biodiesel.

What we are about in very simple terms is ensuring a future where we can eat, drive around and have our buildings stand up. Taking anything that’s waste or green and inedible and turning that into useful stuff such as fuel, and also growing food where it would normally not grow in new areas.

We just saw crowdfunding as a stepping stone. We only had a small objective of $20,000 and the idea of the crowdfunding was just to assist us in getting some equipment we are building in Australia over to Scotland. We didn’t make our target and I’ve been thinking very hard as to why that was the case.

It took about six months of analysis, thinking about it and looking at successful campaigns to see what

we needed to have to have a good shot at crowdfunding. What you need to have is a very catchy campaign, it’s got to stand out, it has to be something so compelling people will see it instantly as it hits the page and almost be compelled to invest in it. Campaigns that seem to raise a lot of money seem to have a good compelling story so our question was what is our compelling story?

I thought we had a good campaign and as the campaign went on we tried certain things to get our message out there through the media, and social media and so forth, and into the more general community. That wasn’t working very well or effectively so I went back and got some more PR advice from another PR lady who was helping with crowdfunding campaigns. We simplified our campaign and pulled it back even more to make it a really simple message. We relaunched it; we did a bit of a Twitter campaign.

We were a bit disappointed we didn’t reach our target. I really seriously question whether we would ever do crowdfunding again for this type of activity because I think crowdfunding was initially meant to be

primarily to support some sort of cause, and as part of supporting some sort of cause or some sort of business that you’d like to see, trying for some sort of change within the community. Now I think it’s primarily, when you look at crowdfunding, and you look at the stuff that’s funded, it’s a lot if IT gadgets and stuff that looks like it’s already in production and it’s very hard to compete with that if you’re doing a crowdfunding of our nature.

However, as a result of our effort on crowdfunding coupled with addition business and technology development we now have an NZ institution that is interested

in financing our global operations.

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