But in the UK, a few stubborn believers decided to develop an extra-terrestrial mega-weapon on their own. They usedKickstarter, the largest and best-known crowd-funding platform in the world. Their challenge to the web community was to come up with £20 million (A$33 million) by April 1, earlier this year. As many as 2,388 people backed the project online, pledging £328,613, but the attempt failed because the target sum was not reached. Ultimately, the star warriors got their money back.
That's common practice for failed venture ideas at Kickstarter, based in New York. But other projects do get funded by internet crowds. Kickstarter claims funding success for 44% of all projects listed on its website. That amounts to 41,000 projects since the company launched in 2009, with more than four million people spending in excess of US$611 million.
What started as a tool for geeks is fast becoming mainstream. “Since 2010, crowd-funding has exploded,” observes Daniel Schlagwein, a lecturer in the school of information systems, technology and management at theAustralian School of Business. “Around 10% of all films screened at the latest Sundance independent film festival [were] funded by the crowd.”
Films are typical projects for crowd-funding, as are CDs, video games and non-profit social enterprises. The Australian platform Pozible, for example, helped finance the debut album of the band Packwood, as well as rebuilding the courtyard of Melbourne's live music institution Pure Pop.
Even product development may now be crowd-funded. One of the most successful initiatives funded via Kickstarter has been Pebble, a customisable wristwatch. It downloads new watch faces, such as sports and fitness apps, and receives notifications from its user's phone. Almost 69,000 people wanted the gadget to be developed and ultimately pledged more than US$10 million to make it happen.
At Kickstarter, all projects must reach their funding goals to receive any money. This all-or-nothing approach is effective in rallying people behind an idea. Crowd-funding is therefore the tool of choice to activate the support of fans and future clients who want to further a desired product or service early on.
Zach Braff, the star of the hospital TV series Scrubs, needed only three days to raise US$2 million for a follow-up to his film, Garden State. Via crowd-funding, film-makers such as Braff retain complete ownership and control over their projects. The return on investment for their backers is mostly intangible. They may get to watch the finished film or a DVD of the work. A bigger pledge to a film project might even win them an invitation to the premiere or a private screening for friends and family.
If a project has received capital but is then not successfully pursued, there are few legal tools to retrieve the money.
“Crowd-funding is based on credibility, the so-called social capital of the artist or entrepreneur, rather than on investment contracts and litigation,” Schlagwein explains. In other words: people who don't deliver will not be able to convince their audience again – and that's a powerful incentive to perform.
Crowds Line Up for Equity
Before crowd-funding, creative entrepreneurs needed to convince a bank, a venture capitalist or a film studio and their shareholders. “With crowd-funding, entrepreneurs outsource the risk of any given venture to future consumers,” says Schlagwein.
“The next logical step is crowd investment and crowd equity, where investors take on property rights in the ventures they back – opportunities that are normally reserved for angel investors.”
And since crowd investing looks like a handy way to fund start-ups, US President Barack Obama signed the Jumpstart Our Business Start-ups Act (JOBS), which will enable entrepreneurs, start-ups and small businesses to raise funds and gather investors through equity crowd-funding.
While the implementation of the JOBS Act in the US may take until the end of 2013, OurCrowd, an Israeli company, is already structured as a hybrid between a venture capital and crowd-funding platform, allowing investors from around the world to invest directly in start-ups. OurCrowd identifies promising early-stage Israeli companies and places them on a platform. To invest, people must be accredited as members and prepared to risk a minimum of US$10,000 per deal. According to CNN, OurCrowd has so far raised more than US$10 million to capitalise 17 companies, injecting US$500,000 on average.
In Germany, the portal Seedmatch allows investors to give start-ups between €250 (A$335) and €10,000 for a vesting time of five to seven years. Should the company make annual profits, investors get dividends and once the venture is sold or floated on the share market, the seed capitalists get their share of the profit. Founded in August 2011, Seedmatch now claims to have raised €4.5 million (A$6.03 million) for 36 start-ups.
The German market for crowd investment has quadrupled in the past year.Ralf Beck, an expert from the Dortmund University of Applied Sciences and Arts, expects a volume of €20 million by the end of 2013 for Germany alone and €50 million in 2014. By comparison, Dow Jones estimates the volume of venture capital spent in Germany in 2012 at €822 million.
But crowd equity raises all kinds of issues. What happens if an investor wants out before the vesting time is over? And who will be the judge when it comes to defining the worth of an investor's investment at any given time? Crowd investors don't buy shares in a venture, but dormant equity or subordinated loans, which basically means they pay, but have nothing to say. Profits and dividends are also scarce because the majority of start-ups fail rather than thrive.
Seedmatch and competitors such as Innovestment or Companisto are not controlled by Bafin, Germany's regulator with oversight on banks and securities. The watchdog's control only kicks in for the issuer of dormant equity holdings worth above €100,000.
In Australia, the corporate regulator ASIC has warned crowd-funding websites that some of their arrangements might constitute financial products that require licensing or the issue of prospectuses. Once the sums get bigger, ASIC may treat crowd-funding as a managed investment scheme, something that is heavily regulated.
Also, crowd investing is not necessarily an altruistic activity to help artists and designers to do their job. Crowd investors gamble that once a venture becomes successful, a big cat comes on board and buys them out. But for venture capitalists, a crowd-funded idea is not necessarily attractive, as Steffen Reitz found out. The CEO of T-Venture, a subsidiary of large German telco corporation Deutsche Telekom, Reitz wanted to take over Smarchive, a start-up that digitises documents to make them searchable. To get a foot in the door, he first had to convince 144 Seedmatch investors to accept the deal. Reitz told German media it was an experience he found less than enjoyable.
But there are plenty of upsides, too. Crowd-funding is not only relatively cheap – Kickstarter, for example, applies a 5% fee to the capital collected – but also a way to avoid intermediaries, such as banks.
“Virtual currencies such as bitcoin, crowd-funding and crowd investing are the first attempts to circumvent traditional financial service institutions,” says Schlagwein. “The peer-to-peer principle is certainly gaining momentum here.”
However, some banks have already jumped on to the bandwagon. The Australian arm of Dutch ING Direct, for example, has teamed up with StartSomeGood, a crowd-funding site geared towards social entrepreneurs. The bank will give grants of?up to A$25,000 to community projects. Anyone can compete for the money by setting two funding goals: a Tipping Point Goal, as the amount that is needed to start doing good, and an ultimate Fundraising Goal, the amount needed to take the project further. If a campaign doesn't reach its tipping point, no money changes hands. If the tipping point is passed but the ultimate goal not reached, the initiator will receive all of the funds raised, including some money from ING.
The funds for this Dreamstarter program come from the bank's marketing budget and will be flanked by the bank's social media activities on Facebook. ING Direct head of corporate affairs David Breen, sees “a great opportunity to leverage the digital medium”, which fits well with a direct bank that trades solely online.
“Social entrepreneurship and crowd-funding are cool,” says Schlagwein. “ING will need to work hard to make the platform more than a PR stunt jumping on a trend and to have the virtual street credibility of Kickstarter and Indiegogo.”