It is well documented that small, start-up firms face
difficulties when it comes to securing external finance, especially following
the economic crisis. To address this problem, and in a bid to help close the ‘finance
gap’, various crowdfunding platforms have been developed; a new source of
finance for start-up firms. With popularity of crowdfunding growing, it is
interesting to see how this process works and whether it is successful for both
companies and investors.
Crowdfunding helps firms secure funding from large
audiences, providing investors with the opportunity to invest very small
amounts through online platforms. The minimum investment is usually as little
as £10. This blog will focus on equity crowdfunding in which people invest in
an unlisted company in exchange for shares. As a shareholder, the investor will
benefit if the company is successful; however, they may also lose their investment
if it is unsuccessful. Around £84m was raised from equity crowdfunding in 2014,
triple the amount from 2013. According to several reports, the platform grew by
410% from 2012-2014, demonstrating its surge in popularity.
An increasing number of companies are using crowdfunding as
well as other forms of finance such as venture capital. This is the case for
JustPark, who run a mobile app which connects owners of parking spaces with
drivers looking for somewhere convenient to park. JustPark is also funded by the international venture
capital firm Index Ventures and BMW’s technology incubator. JustPark invited
its users to become shareholders in a £1m crowdfunding campaign. The company
announced it would use this money to develop new technology and to build its community
of users. The minimum investment was set at £10, encouraging even small
investors to invest.
Kozinets (1999) developed four member types in an online community;
Tourists, Minglers, Devotees and Insiders. The study suggested strategies
should be focused on devotees, who have a strong interest and enthusiasm but
not many social attachments, and insiders who have both strong social and
personal ties. JustPark seemed to adopt this strategy, providing an exclusive
offer to users of the app 48 hours prior to the debut. This encouraged those
considered ‘insiders’ to invest in the company. JustPark offered up to 4.76%
equity, giving the business a valuation of just over £21m.
This strategy proved successful for JustPark, who raised
almost half of their £1m target after only 12 hours of its debut on the
crowdfunding platform Crowdcube. The campaign is now closed, with JustPark
raising £3.7m, marking the world’s most successful equity crowdfunding
campaign. The company also benefited from the increased exposure; experiencing
a surge in job applications and a 300% increase in downloads of the app. This
provided relatively easy access to finance for JustPark, allowing the company
to grow and develop its operations.
However, despite the benefits to businesses, there is some
concern regarding the risks associated, especially as it is a relatively new phenomenon.
The Financial Conduct Authority, the UK regulator, warns that most start-ups
fail and investors are likely to lose their money. It also raised concerns over
how clearly investors are being told the terms of their investment. Many are
exposed to the risk of dilution when more shares are issued. The FCA has made
an attempt to oversee the sector, introducing rules limiting the amount that
can be invested. However, in reality these rules can easily be avoided as they
rely on self-certification.
So, in light of the associated risks, is crowdfunding an
innovative platform that will allow businesses to set up and expand, or merely
a current trend that will phase out once investors start losing money? The
answer is somewhat difficult to comprehend due to how new crowdfunding still
is. To companies, at least, it provides access to funding that might otherwise
have not been available and provides an alternative to loans. They can also
benefit from powerful word-of-mouth marketing and relatively quick access for
funds. For them, I believe an obvious answer would be that yes, crowdfunding benefits
them.
However, it is much more complex from the perspective of
investors. Whilst they have the opportunity to invest small amounts in
companies that interest them, returns are not guaranteed and the relatively unregulated
nature of crowdfunding remains a concern. Some cases look to be a success, such as the JustPark app which received a surge in downloads following the increased exposure. However, this does not guarantee the company can maintain this in the long term, which could potentially result in the destruction of shareholder wealth. I propose
that crowdfunding will appeal to those willing to take a risk and, to an extent,
gamble on their investments. This relates to the indifference curve which represents individual preferences and risk profiles. Those who are willing to take a risk may hold a portfolio that has higher associated risk, in turn expecting higher returns. What is apparent is that, should the sector really take
off, more regulation is required to encourage stability.
References
Belleflamme, P., Lambert, T. & Schwienbacher, A. (2014).
Crowdfunding: Tapping the right crowd, Journal
of Business Venturing, 29(5), 585-609. doi: 10.1016/j.jbusvent.2013.07.003
Curtis, S. (2015). JustPark invites users to become
shareholders in £1m crowdfunding campaign. Retrieved 25th April
2015, from http://www.telegraph.co.uk/technology/news/11408609/JustPark-invites-users-to-become-shareholders-in-1m-crowdfunding-campaign.html
Evans, J. (2014). Equity crowdfunding thrive despite high
risks. Retrieved 25th April 2015, from http://www.ft.com/cms/s/0/3ba47796-7624-11e4-9761-00144feabdc0.html#axzz3YEO9E1Tx
Evans, J. (2015). Start-ups pile into crowdfunding platforms.
Retrieved 24 April 2015, from http://www.ft.com/cms/s/0/c3d01f9a-b75a-11e4-8807-00144feab7de.html#axzz3YEO9E1Tx
Fleming, S. (2015). Watchdogs home in on financial
technology. Retrieved 24th April 2015, from http://www.ft.com/cms/s/0/97b31b68-9da3-11e4-8ea3-00144feabdc0.html#axzz3YEO9E1Tx
Francis, J. & Kim, D. (2013). Modern Portfolio Theory,
Hoboken: John Wiley.
Just Park. (2015). Crowdfunding campaign. Retrieved 25th
April 2015, from https://www.justpark.com/invest?source=awin&utm_source=Affiliate_Window&utm_medium=78888&utm_campaign=Affiliate_Window_Sale&awc=6188_1429958842_89a4a124a8f118e4de88be894d4e360b
Kozinets, R. (1999). E-tribalized marketing? the strategic
implications of virtual communities of consumption, European
Management Journal, 17(3), 252-264. doi:10.1016/S0263-2373(99)00004-3
Winterbottom, A. (2015). BMW-backed car parking app raises
half crowdfunding target on debut. Retrieved 25th April 2015,
from http://www.reuters.com/article/2015/02/13/us-fundraising-uk-justpark-idUSKBN0LH1XJ20150213
