Crowdfunding – the Future of Venture Capital

One of the most significant challenges in starting a new business is
access to finance.

You may also be surprised to hear terms such as crowd-funding, cloud
labour, crowd creativity, distributed knowledge creation and open
innovation. You will be excused for a couple of seconds for nearly
missing the next trillion-dollar wave of business innovation.

For many entrepreneurs first tier funding from a commercial bank is
simply not an option due to

• extremely high security requirements

• very high interest rates

• complexity of schemes

• complex methods of investment assessment

• long lead times

In South Africa there is a health venture capital market with 0.17%
of GDP in funds under management in this sector (KPMG, 2012). This is
down from 0.24% in 2011 but still remains higher than that of China and
Russia as a percentage of GDP. Another fascinating aspect is that 76.9%
of venture capital funding is related to Black Economic Empowerment
(BEE). There is a desperate need to apply venture capital funding to new
business creation and the availability of low cost access to finance
remains a significant hurdle to African businesses.

The real issue is getting access to capital somewhere between banking
rates and micro-lending rates, without the complexity of listings. It
would be logical to try to get a group of investors together to limit
the risk of investment. The challenge is that managing equity schemes is
often very challenging and requires a great deal of savvy to limit the
risk of investors while making good on the return promised to them. Many
a good idea has failed because too many people wanted in, or promises
made panned into the distance.

Banks also require new ventures to have a track record – usually 1-3
years so that this makes it difficult to use the collective will of a
group of people as security for a loan or to get into a new
industry.

The options are usually to

• Save

• Take out a loan

• Take out a second mortgage

• Get a group of people to contribute an amount towards a central
  pool that can be used to seed an investment

• Raise money through family

• Get an angel investor

• Find an early stage venture capitalist that takes a higher stake
  while assisting the startup

• Work through business incubators

Each of these have pros an cons. As usual it is important to
investigate the real cost of the money that you are receiving. While it
is possible to start a business with other people’s money – it is also
important to recognise that no-one is going to give money away for
nothing and as a minimum you will be required to serve the interest on
any amount borrowed.

In addition, you are likely to have to provide security for any
contract or major commitment that your company will enter. This may be
daunting when you have to pledge you and your wife’s assets for your new
business to rent a photocopier.

Crowdfunding falls into the category of funding with the basic idea
being as follows

• A large group of investors, all contribute to a central
  pool

• There is a guaranteed level of reward

• Fees are managed

There are currently an estimated 500 web services that aim to raise
funds for kickstarting web-sites. One such site Kickstarter.com gives a
good example of a well executed service in which different people can
contribute to ideas and “rewards” are given. So in order to raise $
15,000 for a new gameboard development, the creators offered a copy of
the board game to anyone contributing more than a certain number of
dollars. So this means that thousands of people are taking the risk. The
interesting aspect of this is that more than the original $15,000 was
raised allowing the team to focus on further expansion. If you sponsored
more than a certain amount you may get naming rights or a simple thank
you. The web-site will take a fee which for different web-sites range
from 1%-15% for putting together the funding.

Open source is a type of crowd-fundraising. If you like a product,
then contribute to it by promoting it or adding to the code base.
Everyone wins over time.

KPMG, SAVCA (2012) Venture Capital and Private Equity Industry
Performance Survey of South Africa covering the 2011 calendar year.

http://www.kpmg.com/ZA/en/IssuesAndInsights/ArticlesPublications/General-Industries-Publications/Documents/Private%20Equity%20survey%202012.pdf

http://www.sablenetwork.com/documents/SAVCA%20Venture%20Solutions%20VC%20survey_2012.pdf