The Second Million Is the Hardest; Gareth Stokes, Intellectual Property and Technology Associate at the Birmingham Office of Law Firm DLA Piper Considers How Crowd-Funded Projects Need to Adopt a More Corporate Structure to Attract Second-Round Funding
Byline: Gareth Stokes
Crowd-sourced funding has suddenly become the new darling of start-ups. Via web sites such as Kickstarter.com, it promises a way of raising capital and publicising your project or product, generally without the requirements to give up some equity or control that often accompany angel investment or VC funding.
The concept is simple: it is likely to be easier to persuade 100,000 people to give you PS10 each than it is to persuade one person to give you PS1,000,000. Asking more people for smaller amounts means that each individual has a lower sum at risk, and is more likely to want to participate without demanding control or an equity stake in return.
Whilst pledges do not translate into equity in a company, Kickstarter.com and its rivals often encourage projects to offer 'rewards' at particular contribution levels. In the case of a project to start a manufacturing or technology business, these stepped pledges might operate like pre-orders for the product: pledge over PS50 and get a super-deluxe widget delivered as soon as they're ready. This has the secondary advantage of allowing the team running the project to gauge demand and have a nicely-filled order book as soon as the item is ready.
From a bank or VC perspective, crowdsourced funding should be viewed not so much as a competitor as an incubator, breeding the high-growth businesses of the future. Each crowd-sourced project has at least demonstrated it has a good idea, there is public interest in and demand for their product, and they have shown they have the business chops to get the project off the ground.
The difficulty is that there is a world of difference between fulfilling the first few pre-orders received whilst the project was being "Kickstarted" (or featured on some other crowd-sourced funding site), and converting it into a solid independent business. Relatively few projects will be fully bootstrapped by the initial crowd funding, and immediately profitable enough to keep going after that. Most will need some additional finance via the traditional loan or equity routes. Banks and VCs can then swoop in and select the best of breed projects.
This then raises two questions, depending on whether you look at things from the project's perspective or the funder's perspective. For the project team, the question is how to make their project or fledgling company look as attractive as possible in order to secure funding? For the funder, the question is what needs to be done to this project or company to safeguard my investment and give me the best chance of getting a good return? …