Roger Horowitz, left, and Brian Sykora, whose food business was partly crowdfunded
So you want to open an ice lolly shop. You’re 23 years old, a year out of university and bored with web development. Office life doesn’t suit you. You’re restive, uninspired, daydreaming. In Mount Pleasant, your Washington, DC, neighbourhood, restaurants are popping up all over. “I could do that,” you think. You call your friend Roger. In college, the two of you were top rowers, discussing ideas on the way to practice.
You mention artisanal ice lollipops: daring flavours, fresh fruit, local dairy. Roger grew up in a diverse suburb of New York City where Mexican paleterias—ice lolly vendors—were popular with young and old alike. He immediately sees the potential: Latin street food with an American twist.
Thus, in 2009, was Pleasant Pops born: the creation of Brian Sykora and Roger Horowitz. Sykora quit his job, Horowitz moved into his house, and the pair began making ice lollies by hand in a rented kitchen. On weekdays, they took their truck, Big Poppa, down to the financial district to catch bankers during lunch break. At weekends, they catered for young families at the farmers’ market. Hibiscus flower, lavender cream, avocado lime—the stranger the flavours, the better they sold. Their customers weren’t just loyal; they were fanatical.
When Sykora and Horowitz decided to open a bricks-and-mortar paleteria of their own, they launched a campaign on the website Kickstarter. The online crowdfunding website allowed backers around the country—anyone with a credit card—to donate to their epicurean crusade.
Securing a $100,000 construction loan took months of persuasion, plus a Matterhorn of legal paperwork; no commercial bank would lend to them, and a credit union agreed only after the Small Business Administration guaranteed the loan. Their Kickstarter page, on the other hand, was up in a matter of days. It outlined the rewards a donor would receive in exchange for their support: $5 got his or her name inscribed on the “Founders Wall,” $25 bought a ticket to the opening night party. A thousand dollars earned flavour-naming rights, a lifetime supply of treats, and an office party catered by Big Poppa.
The Kickstarter campaign quickly took off. Customers “liked” it on Facebook, bloggers promoted it and donations poured in. In a single day, Sykora and Horowitz raised 60 per cent of their $20,000 goal. Eventually, their take topped $26,000, seed money to purchase equipment and supplies for their empty storefront.
Five months later, the Pleasant Pops Farmhouse Market & Café opened. The mayor showed up to cut the ribbon. Sykora and Horowitz were, at 27, successful small business owners, enterprising foodies, and minor internet sensations. They were living the New American Dream. The business is still running.
Welcome to the gilded age of crowdfunding. Where entrepreneurs once depended on friends, families and fools to fund their ventures, the web offers garage tinkerers and would-be Mark Zuckerbergs the ability to pitch their ideas directly to the masses.
Worldwide, crowdfunding raised $1.5bn in 2011, according to Massolution, the crowdsource research firm. This figure was expected to nearly double in 2012. As Fred Wilson, co-founder of Union Square Ventures, a New York-based venture capital firm, has said, if American families devoted 1 per cent of their assets to crowdfunding small businesses it would inject $300bn into the start-up market—compared to the $30bn now at work from traditional venture capitalists.
It’s an enticing picture and, at a time when banks aren’t lending and unemployment is high, small business finance has never needed innovation so badly. But is crowdfunding a miracle or a mirage? Some say it will support a new vision of work, where people will make their own jobs. Other enthusiasts see it as transforming finance, a swipe at the banks that are so reluctant to lend. Andrew Haldane, director for financial stability at the Bank of England, is enthusiastic about the transformative potential; last year, he told the Independent: “These companies are tiny today but so was Google a decade and a half ago. IT has changed every other industry such as film, music and even football clubs, so why not finance?”
But others (see Andy Davis, right), argue that the sites play on the ambiguity of whether the money is an investment or donation and that, beyond small-scale artistic and media projects, it is unlikely to get far. Outright critics, meanwhile, argue that it will be a magnet for hucksters and fraud, where pensioners lose their savings on risky investments. The “crowd” failed to prevent Enron or the subprime debacle—why should it be trusted to invest wisely in the next Facebook? The Financial Services Authority, which regulates crowdfunding in the UK, strikes a cautionary note, saying on its website that “many crowdfunding opportunities are high risk and complex,” and that it is best left to “sophisticated investors who know how to value a start-up business.” It adds: “We want it to be clear that investors in a crowdfund have little or no protection if the business or project fails, and that they will probably lose all their investment if it does.”
Donation-based crowdfunding sites such as Kickstarter and Indiegogo have become clearinghouses for creativity. Need $100,000 to build a better iPhone dock, or $150 to self-publish Shard of Iron, your science fiction novel about an evil alien empire led by three dragons? Just visit a crowdfunding site, click “Start your project,” follow the instructions, set a funding target and wait for the verdict of the crowd.
On a single day in January, visitors to Kickstarter could browse and possibly fund a huge array of projects. Among these was a device billed as “the incredible egg yolk separator” (over £7000 had been raised—47 per cent of its funding target). Other projects included a rock band looking to produce a new album and go on tour (£18,000 raised), a gadget to give one-handed control of a smartphone when using it as a camera (£18,000 raised); as well as projects to produce books, lamps, clothing and a device for storing “drink, banknotes or even a ready-rolled cigarette in your bicycle’s handlebars,” (£567 raised). This money is offered by supporters in exchange for perks—a free gadget, ticket to a gig, and so on—and, in most cases, a creator collects the money only if the funding target is met, ensuring that backers don’t waste money on ideas that never take flight. The website itself makes money by taking a cut of successfully-funded campaigns of at least 5 per cent.
In just three years, Kickstarter has helped thousands of artists and designers. But now, a new kind of crowdfunding threatens to have an impact beyond the creative class. “Equity crowdfunding” envisages crowdfunders not as whimsical contributors to a passion project, but as investors. This model rewards investors not with gifts, but with equity—that is, a financial stake in the business.
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Like contraception and tillage agriculture, crowdfunding is an old idea made better by technology. Before Kickstarter, there was subscription. Many 18th century authors were supported by patrons. In exchange for coin, a backer was guaranteed copies of the work, plus the pleasure of seeing his name in print. If enough financiers could be found, a project might come to fruition.
Samuel Johnson used subscription to publish his 1755 Dictionary of the English Language, if somewhat grudgingly. The dictionary defined “patron” as: “Commonly a wretch who supports with insolence, and is paid with flattery.” Kickstarter was one of the first companies to bring the subscription model to the web, 250 years later. Perry Chen, a former musician, co-founded the site as a place where artists could fund work that record labels and arts funding councils wouldn’t support. Today, almost 83,000 campaigns have been launched on Kickstarter. Slightly fewer than half have been successful, taking in a total of $398m. In October, the site opened its platform to UK fundraisers—alongside existing sites such as Peoplefundit and Crowdfunder—and in the first month British campaigns attracted more than £2m in pledges, or roughly£48 every minute.
Kickstarter is only part of a wider shift in the way we bankroll culture in the 21st century. In 2007, pre-Kickstarter, Radiohead sold their seventh album, In Rainbows, directly to fans via the web, using a give-what-you-can model. More recently, Andrew Sullivan, the blogger and Sunday Times writer, announced that he was leaving the Daily Beast website to strike out on his own. Readers who wanted to subscribe to his blog, The Dish, could do so for $19.99 a year—or more, if they were feeling benevolent.
But what if crowdfunding could produce not just albums but whole businesses? And what if backers were not donors but investors, motivated not by altruism but by profit, who expected more than perks: equity, dividends, maybe even a seat on the board?
Equity crowdfunding works in the same way as the donation-based kind—ventures are only funded if enough investors sign on—but the risks are higher and the money bigger. Fraud is one concern—con men preying on retirees and shysters out to make a quick buck. So far, however, these fears have not been borne out. The more relevant issue is: what happens when you “kickstart” a great idea and it doesn’t work? When the low-budget film you donated to ends up being rubbish, you may be disappointed, but you’ve only lost £25. When the technology company you bought equity in goes under, you’ve lost £10,000—potentially more.
Equity crowdfunding sites have been active in the UK since 2011, but the practice became legal in the United States only in April 2012 with the passage of the Jumpstart Our Business Start-ups Act. Previously, securities law restricted American entrepreneurs from selling equity—shares in a private company—to most “unsophisticated” or “unaccredited” investors. A company couldn’t even publicly advertise that it was raising money.
All that changed with the JOBS Act. The Securities and Exchange Commission (SEC) is still writing the rules, to take effect by 2014. When they do, small businesses will likely be free to both advertise equity publicly and accept investors—rich and poor, accredited and not. There will probably be a scramble to do so.
The legislation has vocal naysayers, among them traditional financiers. The North American Securities Administrators Association called crowdfunding its “top investor threat” of 2012. William Galvin, Massachusetts secretary of state, wrote a letter to the SEC in August stating that: “Longstanding problems in the markets for small and speculative stocks show the pitfalls of relying on the wisdom of crowds. It is clearly possible to deceive large groups of investors, and it is definitely possible for fraud operators to swindle individuals.” Bernie Madoff, convicted in 2009 of running an $18bn Wall Street fraud, is regularly invoked as the kind of operator who misled intelligent people and even the SEC itself.
It’s also not clear that drawing investors at random from the crowd makes for healthy businesses—or sane business owners. “A lot of investors want be connected to the business, which may not be as attractive to the entrepreneur as it seems,” Eric Paley, co-founder of an early stage venture capital fund, said. “All the people who say, ‘I really want to help.’ It’s like, ‘Yeah, but you’re not that helpful. You’re distracting me.’ If you’ve got 100 investors and 30 want to help, it can get pretty awkward.”
But equity crowdfunding has plenty of cheerleaders, too. “It’s going to completely open up capital markets to all kinds of things that we’ve never thought could raise money,” said Robert Litan, the former director of economic studies at the Brookings Institute and now director of research at Bloomberg Government, a division of the news service.
Litan thinks that regulators worry too much about swindlers and class-action lawsuits. “When eBay got started, people were all worried that it was going be a total magnet for fraud. What eBay figured out was a system to rate people, whether they’re trustworthy or not.”
Advocates argue that it’s easy to trick one investor—but it’s a lot harder, maybe even impossible, to trick 10,000. “You’d have to defraud your whole family,” one entrepreneur told me. The herd does have a way of sniffing out chicanery, from shoddy product designs to fantastical revenue projections. Thanks to Google, basic due diligence can now be done from the sofa. And thanks to social media, no rumour stays quiet for long.
“I think this idea of crowdfunding being a bastion of fraud, and bamboozling the unsophisticated populous, it’s bogus,” said Jonathan Sandlund, an erstwhile investment banker who edits a website devoted to the topic. Sandlund points to the British company Crowdcube, based in Exeter. Launched in 2011, the site has raised just under £5m for start-ups and counts more than 27,000 investors among its users. So far, not one of them has been, as Sandlund has it, “bamboozled.”
The idea behind Crowdcube is simple. Until recently, small business finance was stuck in the 20th century. Intricate hierarchies of angel investors—high-net-worth individuals who offer risky start-ups seed money—dictated what, and who, got funded. Crowdcube’s founder, Darren Westlake, created, in essence, the world’s largest networking lunch, where investors can read through hundreds of pitches, see who else is backing a project, and put down money of their own.
Not all financiers are comfortable with Crowdcube’s business model—Westlake says he’s currently seeking FSA authorisation—and the platform already has competition. Seedrs, which launched in July, crowdfunds yet-to-be-profitable start-ups, and takes a cut if the company later cashes out. Unlike Crowdcube, it’s authorised by the FSA and is open to all investors, regardless of income.
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But there’s a catch, one that regulators worry most people don’t understand: equity in a private company is what’s known as an illiquid asset; it can’t be easily sold. When you own stock in Vodafone and suddenly need cash to buy a new car, you can simply dump your shares. But when you own a 2 per cent stake in a start-up that makes robotic pet litter boxes—let’s call it Happy Kitty Co—your investment is, for the moment, worthless. Until Happy Kitty lists its shares on a stock market, or is bought by a larger company, or big investors put more money in, there’s no way for you to sell your share. It typically takes four to seven years for such a “liquidity event” to arrive, and that’s the best-case scenario. Because if Happy Kitty declares bankruptcy and sells all its assets at a huge discount, that, too, is a liquidity event—only you won’t be getting that new car.
The granddaddy of crowdfunding, Kickstarter, has said it’s uninterested in abandoning its donations-and-rewards model, no matter how lucrative the equity business model promises to be. “We’re going to keep funding creative projects in the way we currently do it,” Chen told the tech website “GigaOM” in May. “We’re not gearing up for the equity wave if it comes.”
But Kickstarter’s close cousin, Indiegogo, will probably try. If Kickstarter is a carefully curated art gallery, Indiegogo is something closer to a garage sale. Originally a site for fledgling filmmakers, (see Nick Hilton, left) Indiegogo has become the go-to platform for ideas that don’t fly elsewhere—scholarships, vacation funds, medical expenses—plus the usual slew of novels, recitals, and save-the-local-bakery campaigns. “We have an open platform where anyone can create a campaign,” co-founder Danae Ringelmann said. “There’s no application. There’s no judgment. There’s no rejection. There’s no waiting. You have an idea? We don’t believe it’s our right to decide if you can raise money or not.”
I recently stopped by Indiegogo’s headquarters, on a warehoused artery near the heart of San Francisco. The firm seemed to be outgrowing its office like a hermit crab outgrowing its shell. With one conference room booked and the other given over to bike storage, we sat at the kitchen table. Two pugs played at our feet, and every so often, an employee—dressed college campus casual—wandered through to fix a shot of espresso or bowl of oatmeal. Graffiti adorned one wall: “Go fund yourself.”
Ringelmann, a former investment banker at JP Morgan, came to crowdfunding as a frustrated financier. Ten years ago, she accepted a chance invitation to a “Hollywood meets Wall Street” networking event.
“It was a sea of emerging artists, and I was one of a handful of bankers,” she told me. For several surreal hours, she tried to explain that, not only was she a junior banker, but she didn’t finance films. “They didn’t get it, because all they saw was ‘JP Morgan’.” Two days later, she received a FedEx package from an aging filmmaker. He’d spent $15 to post her a script from Los Angeles. “I look forward to you financing my film,” he wrote. Ringelmann realised that the people who most wanted to bring art to life didn’t have the power to make it happen. “So I quit finance and went back to business school to do it,” she said, “because I was sick of hearing myself think about it.”
Indiegogo has made significant innovations on the Kickstarter model. Creators keep all the money a project raises, regardless of whether they hit a pre-specified target. And it has spent three years building a fully-automated website; it does not want to emulate Kickstarter in having a real person, rather than a machine, review every campaign before it goes live. “It’s very unscalable,” Ringlemann said of the Kickstarter model. “If YouTube had required people to apply to upload their videos, YouTube would not be the company it is today. We’re a YouTube for funding.”
Provided that the SEC’s forthcoming regulations aren’t too onerous, this laissez faire approach will allow Indiegogo to turn equity crowdfunding into a big business. “In working out which models work and which don’t, there will be massive failures,” she allowed. “There will be fraud. There will be people who mess up. And there will be a lot of backlash.” Regulators need to get comfortable with the idea that there will be mistakes, she argued. But this should not be used as a reason to prevent a potentially transformative industry from evolving.
“The ‘middle man’ has been disintermediated in a number of industries over the past few years—music sales, publishing, second-hand goods—courtesy of the web,” Andrew Haldane told me. “From a consumer perspective, they have been for the better.” Equity crowdfunding, he suggests, now promises to revolutionise finance in the same way.
Platforms where anyone can sell equity and anyone can invest are an attractive possibility, but that doesn’t mean they make business sense. Most people have never parsed a terms sheet or investor rights agreement and, whatever the SEC decides, it’s probably not wise for the general public to start buying illiquid securities online. The genius of Kickstarter is that people can support a person with a dream through donation—but making an investment is far more serious. It demands trust and loyalty, which most of the internet crowd are not willing to give. They’re better suited to the spring fling, the passing fancy. Like most people, they want only to enjoy the ice lollies while they last.
Will crowdfunding stay small?Andy Davis
Crowdfunding will grow, though possibly more as a way to fund passion projects rather than businesses. Selling equity to the crowd is going to become important, but it will be a long time before it rivals the big sources of early-stage equity investment.
Another problem is the lack of liquidity—it’s getting easier to put money into start-ups and private company shares, but harder to get it out. This is because the number of companies being offered for sale by flotation on the stock market has declined, as have the sales of whole companies. The real issue is that most people—“the crowd”—have no idea how hard it’s going to be to get their money back. Unless that changes, doing something that’s more akin to donation, as with Kickstarter, makes sense (though people appear to think they have purchased something when they donate.)
Equity crowdfunding is exciting, but it will be a long time before we can gauge its full significance. Without a revival of the traditional exits (stock market flotations, trade sales and buyouts), people could easily end up losing patience with it.
Andy Davisis Prospect's investment columnist
How I did itNick Hilton
Crowdfunding for technology projects is one thing, but everyone knows that the real test is running an arts campaign. When I started the Indiegogo campaign for my film, in the summer of 2012 (Kickstarter UK had not yet launched), I was relatively naïve about the process and only took into account one big positive and one big negative. The big positive was that the media and entertainment community were very social media savvy and getting retweets on Twitter was about as difficult as putting on a hat. The big negative, however, was that getting money from those same, impoverished and unemployed, people was like drawing blood from a liberal arts degree.
My film, a dark comedy about dog-kidnappers called The Flight of the Flamingo, was seeking $7,000—a conservative figure, even in the world of low-budget filmmaking—and the fundraising ran for 40 days. Those 40 days were among the most stressful of my life, as I juggled incessantly badgering people for donations with trying to pass my Oxford preliminary exams (not my greatest feat of scheduling). Writing blogs about movies and student life helped. About half of our final total ($7,620—safely above our baseline goal) came from family and friends. The rest came mysteriously via Twitter, Tumblr, web forums and various other dark recesses of the internet.
Our largest contribution was $2,000, donated by an eccentric German investor. In return we gave him a cameo in the film.
Reaching our goal was down to endurance and blind optimism, not skill. When it comes to crowdfunding for arts projects, it’s one part luck, two parts hard work and, if you’ve got that unnecessary garnishing—talent—well, that might help a little too.
Nick Hilton is a student at Oxford University and blogs about films as The Clapper Bored
