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Crowdfunding: Is it right for your startup? (part 1)

January 15, 2013

Crowdfunding: Is it right for your startup? (part 1)

Note: This is the first of two blogs on the topic of crowdfunding. Tomorrow’s post gives an overview of a potential crowdfunding exemption that the Ontario Securities Commission (OSC) is currently reviewing that would enable the issuance of crowdfunded equity for local companies.

Remember when you were a child and needed to raise money for something special (e.g., to build a treehouse or buy a bike or toboggan)? In my case, I would ask every family member to donate to my cause. In a way, this was a form of crowdfunding: soliciting funds from a group of individuals to help build or buy something special.

Fast-forward a decade or so (in my case a depressing 30 years), add technology advances and business methodologies and we now have entrepreneurs raising funds not only to build something special, but to change the world in the process.

What is crowdfunding?

According to Wikipedia, crowdfunding (sometimes called crowd financing, equity crowdfunding or hyper funding) “describes the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations.” In MaRS’ case, entrepreneurs could use crowdfunding to fund their startups.

The “poster child” among startups using crowdfunding today is watchmaker Pebble, which used a reward-based model to raise US$10.27 million from 68,929 people, making it the most crowdfunded startup. According to Crowdsourcing.org, crowdfunding platforms raised $1.5 billion globally in 2011.

Pros and cons of crowdfunding

There are many pros and cons associated with crowdfunding for Ontario entrepreneurs. MaRS client Myke Predko, co-founder and CEO of Mimetics Digital Education, says: “Crowdfunding provides an excellent way for entrepreneurs/startups to get their message out to prospective customers in a low-cost, low-risk manner.”

But it might not be for everyone. Here is a short list of the pros and cons:

Pros

  • Allows good ideas that do not fit the conventional pattern to break through
  • Generates validated early adopter “traction” from the crowd
  • According to James Surowiecki in his book The Wisdom of Crowds, it “produces an accurate aggregate prediction,” which can be favourable for follow-on investment
  • Potentially increases the amount of capital entering the startup ecosystem. Imagine if every Canadian family gave 1% of their investable assets to crowdfunding?

Cons

  • If you succeed it’s public; if you fail it’s public
  • Time and effort to raise awareness of a crowdfunded campaign since crowdfunding platforms cannot advertise projects
  • Managing demand if the product takes off (like Pebble)
  • If yours isn’t a tangible product, you may not be able to raise enough money. Social innovation company SoJo discovered this when weighing the pros and cons.

Crowdfunding models

There are various crowdfunding models:

  • Equity-based crowdfunding—investing for equity ownership that will generate financial returns
  • Donation-based—more often used to support charitable efforts or political campaigns
  • Reward-based—pre-ordering a new product or receiving a perk
  • Peer lending—an online broker facilitating loans from individuals to fund a business

Examples of leading crowdfunding platforms

A crowdfunding platform’s primary revenue model is a percentage-based commission on funds paid out to entrepreneurs. A few also generate income by offering white label solutions and cash management by maintaining responsibility for netting and settlements (Source: Crowdsourcing.org).

Hot topic in Ontario: Equity-based crowdfunding

The hottest topic in crowdfunding in Ontario today concerns the equity-based model, specifically “from whom” and “how much” can be raised by a startup company through these platforms given existing securities rules and regulations.

Equity-based crowdfunding is currently not permitted in Ontario or in the rest of North America, but it is expected to be available in the US in early 2013 and is already available in the UK and Australia.

Borrowing some of the concepts from the American JOBS Act, the Ontario Securities Commission (OSC) is currently reviewing a potential crowdfunding exemption to enable the issuance of crowdfunded equity for local companies. As a first step, the OSC has produced a detailed paper for review and comment (OSC Staff Consultation Paper 45-710: OSC Exempt Market Review).

To continue reading about the OSC’s proposed crowdfunding model and find out how you can get involved, please stay tuned for Part 2 of this blog post tomorrow!