The pros and cons of crowdfunding

Raising money for a startup used to be difficult, but now there are almost too many options. Venture capital, angel investment, startup accelerators, crowdfunding, private equity, IPO, and now cryptocurrency ICOs are all potential avenues for early stage businesses.

Traditionally, startups have raised “seed rounds” from angel investors or accelerators, and then gone onto larger rounds with VC firms if required. For example, kiwi online video startup 90 Seconds was founded in 2010 and survived on angel investment rounds in the $250,000-500,000 range until 2016. Then it did a large round of US$7.5 million, led by VC firm Sequoia India.

Crowdfunding operates mostly at seed capital level, but our government allows companies to raise up to $2 million in equity crowdfunding on platforms like Snowball Effect and PledgeMe.

Snowball Effect helped Zeffer Cider raise $2.4 million (including wholesale and retail investors, which don’t count against the $2 million limit), while wine exporter Invivo raised $1.7 million.

PledgeMe enabled brewery Parrotdog, medical cannabis producer Waiapu, and chocolate maker Ocho to raise $2 million each. Waiapu’s funding campaign was so popular it reached the $2 million mark in just 10 minutes.

Parrotdog has now done two PledgeMe campaigns, raising a total of $3 million over 2016-17. So already it has raised roughly three times as much via crowdfunding as 90 Seconds raised from angel investors.

Another benefit of crowdfunding is that if you play your cards right, you won’t have to give away as much equity. In its initial 2016 raise, Parrotdog’s founders gave up 16.81% of equity. In its second raise in 2017, it was 7.75%. That’s just under a quarter of the company in total. Not bad for two fundraising rounds of over $1 million.

The main reason Parrotdog’s founders were able to keep over three quarters of their shares is the extras the company threw in to keep their crowd happy. As well as equity, PledgeMe investors got beer discount cards, a “complimentary birthday pint,” invitations to the brewery open day, and even an option to host your own event at the Parrotdog bar (for the premium package). In other words, there were a number of cool perks.

Of course, it helps to run a company that sells items with popular appeal. Can companies that don’t sell booze, cannabis or chocolate raise $2 million via equity crowdfunding?

I asked that question to Anna Guenther, founder of PledgeMe (which is currently raising another round, up to $899,000, on its own platform).

“It’s naturally easier when you have a product people love,” admitted Guenther. However she pointed out that companies with a sense of social responsibility can also do well. For example, accounting company Thankyou Payroll managed to raise $460,000 on PledgeMe, thanks partly to its offer to donate 25 cents to charity from every payroll processed.

Guenther told me there are other benefits to crowdfunding, including that more women are raising funds through crowdfunding than via traditional investment vehicles.

“The traditional financial markets haven’t been that welcoming of diversity,” she said. “Often those institutions pattern match what they’ve seen work historically, which has been predominantly companies led by white men.”

Indeed crowdfunding may actually play to the strengths of women, says Guenther.

“What we’re seeing with crowdfunding is women are often quite good at building community, so when they want to go out and raise money they activate the community they already have – rather than pitching to a new one that might not see them as matching the pattern or behaviour of previous investments.”

It’s certainly a good thing that women feel more empowered to raise money for their companies through equity crowdfunding. But what are some of the drawbacks of this approach to raising funds?

For expert comment I asked Rowan Simpson, one of the founding team at TradeMe who went on to become an early investor in Xero, Vend and other kiwi startups.

“There are obvious pros and cons of crowdfunding,” said Simpson. “It’s potentially easier than seeking venture capital funding, especially if you already have a crowd of customers or supporters who you can raise from. However, it does leave you with a long list of smaller investors on your share register, who may or may not be able to continue to invest in future rounds.”

Simpson also noted that crowdfunding leaves companies “potentially without a lead investor who is prepared to roll-up their sleeves and help to contribute to the success of the venture, with the advice and connections that are hugely valuable in the early stages.”

So has crowdfunding changed the investment landscape significantly? It’s been seven or eight years since Kickstarter, Indiegogo and similar platforms began to gain popularity. PledgeMe was launched soon after, in 2012.

For all the success stories (such as Parrotdog), there have also been notable failures. Renaissance Brewing crowdfunded $700,000 in 2014 on Snowball Effect, but went into voluntary administration last October.

Rowan Simpson is one who doesn’t think crowdfunding has lived up to its initial hype.

“There was a time when crowdfunding was being talked about as the innovative new way that all companies would raise capital,” he said, “but I’m not sure we’ve really seen it get the expected traction yet.”

However, Simpson thinks crowdfunding may yet evolve into “something that looks quite different to what was originally proposed.” He pointed to PledgeMe’s Tā Koha initiative as a development that “will be interesting to follow.” PledgeMe is touting Tā Koha as “a new way for Māori entrepreneurs to raise capital by involving their whānau.”

In summary, clearly there’s no best way to fundraise. But for startups or organizations that can appeal to a large crowd of people – whether that be family, friends, fans, or customers – equity crowdfunding is a great option.

From an investor point of view, the best thing about equity crowdfunding is that it’s much easier to do than angel investing. Although I wonder about the wisdom of investing in a beer company (for example) just because it’s a crowd favourite.

That said, crowdfunding can’t be any riskier than investing in an ICO that doesn’t even have a product yet. And at least you’ll get free beer.