Economic growth

Crowdfunding innovation

Yannis Pierrakis and Liam Collins - 25.11.2011

Could crowdfunding be a long-term source of capital for those seeking to finance social, creative or business ventures?

The new financing landscape of tighter credit availability is favouring the growth of alternative sources of finance. But some of the existing alternative models of financing are not currently meeting the needs of businesses or investors. Examples of the failures of the current models include the difficulty of firms in accessing debt financing[1], the poor returns of venture capital over the last decade[2], the persistence of 'equity gaps'[3], the difficulties capital intensive ventures face in getting capital[4] etc. These failures along with advances such as the explosive growth of social networking have given rise to a plethora of innovative models of how finance can be provided to business.

Crowdfunding is one such new source of financing which harnesses the power of the crowd to fund new ventures. It is already quite prevalent in the area project specific funding in the social and creative sectors with big players such as Kiva and Kickstarter facilitating a large number of investments to individual projects or companies. An example of the scale of capital these platforms can summon from their members was the recent raise of $200,000 by social media site Diaspora on Kickstarter. The practice has also spread to the UK with sites such as PledgeMusic, Wedidthis and the recently launched Peoplefund.it and Bloom, which have both received support from NESTA.

An interesting new development on this type of funding is its expansion in the area of crowdfunding entrepreneurial businesses. Although this has existed to some extent through platforms like those mentioned above it has mainly operated by companies offering rewards for donations or via the pre-purchasing of products or services. Two UK companies are however pioneering the provision of finance through lending and equity investing from the crowd. Fundingcircle, founded in 2010 allows the general public to directly lend to businesses seeking finance, allowing them to quickly access capital without having to go through the banking system. So far several thousand lenders have provided loans worth some £24 million. Crowdcube, also launched in 2010, allows individuals to take an equity stake in a company raising finance. The latter has had to overcome significant regulatory barriers that make it difficult to offer this type of investing opportunity to the general public. Arguments in the US that regulation in this area is too strenuous has been heeded recently with the US House of Representatives passing a bill earlier this month that will allow 'the crowd' to invest more freely into businesses.

Crowdfunding supporters argue that while raising money is the most important benefit the platform provides, another important advantage of this new source of finance is the power of "collective intelligence" i.e. the ability to mobilise the wisdom of crowd by asking investors to actively participate in new product development (e.g. by voting on their preferred product or services) and actively contribute to the due diligence of the opportunity by sharing their expertise. In addition, through crowdfunding, ambitious ventures can attract public attention to their products or services. Others are more sceptical about the protection that such initiatives offer to investors and raise concerns about the scalability of this financing model.

Following on from this debate, NESTA is currently undertaking a large scale research project looking at new sources of finance aiming to create a more diverse market in finance provision and fund those ventures that would otherwise find it difficult to access the capital they need.

We are looking at all the various models of crowdfunding currently existing in the market, the people who are lending through them and the ventures that are seeking this new type of finance. We will be examining the current regulatory environment and seeing if and how it needs to adapt to the changes brought about by these emerging instruments.

If you are a crowdfunding provider and wish to participate in this search please contact liam.collins@nesta.org.uk

[1]Beyond the banks, NESTA 2011

[2] Atlantic Drift, NESTA 2011

[3] From Funding Gaps to Thin Markets, NESTA 2009

[4] Financing Industrial Biotech in the UK, NESTA 2011