By David Drake
Crowdfunding works like a cockfight where you raise your bet and anybody from the crowd takes the challenge. The only difference is that in a cockfight it is a 50:50 win-loss probability. In crowdfunding, risk is spread into different offerings and an investor has options to manage risk by conducting due diligence on the target proponents.
Investor Insight mentioned how, in 2007, Slice the Pie made use of crowdfunding to solicit fund for their music production and recording from their fans through their website Slicethepie, and it is one of crowdfunding early success story. Zopa has already started the Peer-to-Peer (P2P) lending in 2005. Notwithstanding, it is not an issue of which came ahead. What Zopa and Slice the Pie have achieved mirror a new wave of fund sourcing for projects that bankers and stockbrokers would normally ignore. This is also something that bankers would worry for the success of crowdfunding would greatly affect banks’ interest rate.
The attractiveness of crowdfunding can be best explained from the experiences of the following companies that benefitted from this new financing trend.
If Slice the Pie solicited fund from their followers, Hotel Chocolat offered investment to their customers. With their strong brand image, trust was already established.
Hotel Chocolat offered an annual return of 6.72 percent for an investment of £2,000 or 7.29 percent for an investment of £4,000. What is unique in this offering is that the promised return will not be paid in cash but with chocolate. This is not possible in the capital market or banks.
Bankers may view this as silly, but to Hotel Chocolat customers and investors the bond offers both investment and derivative. What is unique is the yield on Hotel Chocolat bonds is paid in boxes of chocolate ranging from 6 to 13 boxes a year depending on the amount of investment.
On the part of Hotel Chocolat, they will enjoy higher cash reserve since bi-monthly yield payment are taken from inventory not from cash.
This crowdfund offering netted Hotel Chocolat £3.7 million, mostly from their existing customers. Who will be interested in bi-monthly payment of bond-yield in chocolate if not the customers?
The funds that Hotel Chocolat raised through crowd offering was used in capacity expansion in Cambridgeshire projected to create 250 new jobs, building sustainable factory, more retail outlets and expansion of existing cocoa plantation in Saint Lucia.
As reported by RealBusiness, Caxton FX founder Rupert Lee-Browne said, “Growing, profitable companies can’t raise funds easily anymore. It’s much more difficult than it was four years ago. The way that banks are behaving – and their attitude to growth businesses – is plain wrong.”
Actually, for Caxton FX, it is easy to raise funds through banks or private equities, but the requirements and guarantees that banks or private equity owners want are not worth the net proceeds.
Ecotricity issued the first bond expected to reach £10 million EcoBond on October 2011, and due in 4 years with 4.5 percent yield. The bond was over subscribed with 80 percent from existing customers. The amount generated was for the renewable energy project for the benefits of Ecotricity customers.
Growth and Potential of Crowdfunding in the UK and US
Crowdfunding is a variation of savings and loan wherein members pool their fund and lend exclusively to members. With the web, the base called “crowd” has expanded and gone beyond boundaries. (Kiva is funding projects in developing countries around the world through debt crowdfunding since 2004.)
The proponents called crowdfunding as “new phenomenon”, skeptics call it “new bubble”. What makes crowdfunding phenomenal is the use of the web and social media in connecting fund holders and users. However, we can’t categorize crowdfunding as a bubble per se. As a platform and network, like banks, it can create a bubble if abused. The difference is, the public has very limited access as well as expertise to peer on and evaluate the activities of banks compared to the transparency in crowdfunding. Once a proponent post a project on a crowdfunding platform, anybody can conduct due diligence. In fact, it is easier to defraud bank depositors than the crowd.
While there is no specific government regulating agency in the UK, they have Financial Services Authority, a non-government organization, that regulates crowdfunding activities. With the Jumpstart Our Business Startups Act (JOBS Act), the US Securities & Exchange Commission has regulatory power over the crowdfunders but limited to equity crowdfunding. However, for Peer-to-Peer lending there is no specific agency that is in control. As in any industry, at infancy stage, rules are not established. As the industry matures, a regulatory body could emerge. At present Peer-to-Peer lending operation in the US will just be self-regulatory.
Learning from the UK Crowdfunding Experience
There are several registered crowdfunding companies in the UK but the most popular are Zopa, Relendex, Rate Setters and Funding Circle. Although all are operating as P2P lending, each company focuses on a chosen niche and different market segment.
On the part of fund-seekers, apart from their difficulty in passing the banks or private equity managers’ criteria, many would avail of crowdfunding services mainly for lesser cost, documentary and procedural requirements.
On the other hand, investors are attracted to crowdfund offerings because of the yield, magnitude of amount involved, spread of risk and less red tape.
Note: This article originally appeared on HedgeCo.Net with this link http://www.hedgeco.net/blogs/2014/08/27/going-into-crowdfunding-discover-3-success-stories-that-dared-to-say-no-to-the-banks-by-david-drake/ on August 27, 2014.
David Drake is an early-stage equity expert and the founder and chairman of LDJ Capital, a New York City-based family office, and The Soho Loft Media Group – The Voice of Capital Formation – a global financial media company with three divisions: Victoria Global Corporate Communications, Times Impact Publications, and The Soho Loft Conferences. You can reach him directly at David@LDJCapital.com.
Images are from worldchocolateguide.com, caxtonfx.com, i.telegraph.co.uk