Recently I came across a company that had raised $3M and created a prototype service but they didn’t sell nearly enough to make it a going concern. In their research they established that there was a need for a product similar to theirs but the feature set was so different that a re-write would be required. Let’s say they offered you 5% of the company to be the CEO… should you jump at the prospect or simply say “Thank you, but no!”?
There’s another source of funds for entrepreneurs appearing… It allows unsophisticated members of the public to make small investments into companies that require funding. How does it work? Who does it? What are the benefits? Are there disadvantages?
Crowdfunding is a loan from lots of people (the crowd) to a company which is managed by another company in the middle. The managing company will carry out some due diligence and may require security before the proposition is presented to the crowd for funding. The company ends up with thousands of loans for small amounts (e.g. £10) in order to make up the full funding requirement. The management company collects the interest and capital (at the end of the loan) and distributes it to the crowd during the term of the loan.
Internet companies have been creating an automated process for combining these small sums, calculating and then allocating interest payments. Lenders benefit because their loan is divided between many recipients so if any recipient fails, they do not lose their whole loan. Since running the internet market place for lenders and borrowers is considerably cheaper than running a bank, fees can be lower. This translates into lower interest rates for borrowers and higher returns for lenders.
Starting in 2005, Zopa was one of the first Crowd Sourcing companies (they started before the term existed). Instead of companies, they manage personal loans. Zopa has managed over £100 million in loans already and expects to manage £140 million in 2010. They can provide personal loans of £1000 to £15,000 for 3 to 5 years subject to affordability. The interest rate depends on the credit score from a credit bureau and how long you wish to borrow the money.
FundingCircle are aimed explicitly at businesses which have been trading in the UK for more than two years, the Funding Circle loans range from £5,000 to £50,000 for 1 to 3 years at a fixed interest rate.
Firstfunding.org is another organisation which is just starting to operate. They charge companies a £95 fee to review the funding request and then 2-5% of the gross value of the loan made. Companies are typically looking for loans of £150K to £500K with an interest rate of 10%.
A fourth option is Crowdcube which is a pioneering new service that allows entrepreneurs to raise money for their business venture by offering real equity in exchange for investment from a “crowd” of investors who want to invest small (or large) amounts of money in support of an idea, person or business.
What are the advantages and disadvantages for companies?
- +ve No sale of equity required.
- +ve Outsource the problem of finding investors.
- +ve Cheaper than Business Angel, Venture Capital and, in some cases, bank funding.
- -ve You don’t know your funders (i.e. prevention of money laundering could be an issue).
What are the advantages and disadvantages for investors?
- +ve If a company goes under, you don’t lose much money.
- +ve Might provide a better return than banks if companies chosen wisely.
- +ve Lots of companies looking for money to choose from.
- -ve There is no history to base information about likely returns.
- -ve Don’t need may failures in portfolio for the portfolio to make an overall loss.
In summary, if you’re on the board of a company needing funding, now is the time to look at Crowd Sourced Funding. As far as I can see, it will work for the first year or so until (a) investors start thinking about their returns; and/or (b) the Financial Services Authority start investigating the promotion of company debt to the general public.
I welcome another source of funding for companies although I wouldn’t be an investor!