Crowdfunding for entrepreneurs

Eric Migicovsky is a crowdfunding success story. The entrepreneur originally wanted to raise US$100,000 to fund production of his Pebble watch, a wristwatch that employs an e-paper screen and pairs with iPhone and Android devices to deliver smartphone functionality to owners’ wrists. Migicovsky wanted US$100,000, but he ended up with US$10,266,845. And all without giving away a single piece of equity.

Migicovsky raised the money using Kickstarter, one of a growing number of sites offering start-ups the chance to crowdfund their operations. Crowdfunding is similar to crowdsourcing, but with money. Start-ups can post their projects and ask for financial help, and people donate money to bring those products and services to fruition.

Different approaches

Crowdfunding works using a variety of models. One of the most popular is pre-ordering, in which a company takes advance orders for a product and then fulfils the orders when it ships. This is how Migicovsky raised his funds, and it can be particularly useful as a form of market research, said Eric Corl, founder of U.S.-based funding platform Fundable. “If entrepreneurs don’t raise that money, then what a great way to have tested the market.”

But pre-ordering isn’t the only option. Some projects use a patronage funding model, in which interested parties donate simply because they wish to see a project completed. Many entertainment projects such as films and books fall into this category.

Another model is rewards, in which, instead of taking pre-orders, contributors are given goodies ranging from T-shirts and party tickets through to advisory board memberships, depending on how much they donate.

You want a piece of me?

But one of the most contentious models is equity: donors receive a piece of the start-up company itself. In the U.S., equity crowdfunding was illegal until President Obama signed the JOBS Act into law this April. This enabled unaccredited investors to pile the lesser of $10,000 or 10 per cent of their income into a start-up business using funding portals. The SEC is now creating rules to govern the implementation of that law.

Up in Canada, however, equity-based crowdfunding is still illegal. This is frustrating advocates such as John Reid, president and CEO of high-tech business association CATAAlliance. “Right now, we are lagging our sister economy,” said Reid, who warns that equity-based crowdfunding is badly needed in an economy plagued by a funding gap. In 2011, venture capital funds in Canada rebounded a little, but the $1.5 billion from firms north of the border still fell short of the $2.1 billion available in 2007 according to CATA, and that figure was lower than in 2001.

“We are not embracing digital platforms. We do not provide the crowdfunding mechanism so that companies can exchange micro-equity.” Reid added that if Canada doesn’t support equity-based crowdfunding, we risk bleeding start-up talent to the south. “The federal government has a role and it’s a federal responsibility,” he said. “There hasn’t been a whole lot of leadership.”

Watch and wait

On a provincial level, which is where securities regulations are made and enforced, things are moving, albeit glacially, to free up equity funding for Canadian start-ups.

On June 7, the Ontario Securities Commission announced that it was broadening the scope of its exempt market review. It will consider whether to add new rules to help start-up funding. “We are planning to publish a second consultation note this fiscal year to seek further feedback on the exempt market regulatory regime and to explore whether the OSC should adopt any new prospectus exemptions and, if so, under what circumstances or terms,” said corporate finance director Leslie Byberg. It will also keep an eye on the JOBS Act.

Watching and waiting is a good idea, said Paul Dombowsky, who started FundChange, a social innovation crowdfunding platform sponsored by Telus. He anticipates problems stemming from the JOBS Act, which he thinks could contradict the requirement for quick and easy push-button donations inherent in social media. “For the most part, you have a lot of entrepreneurs funding a lot of entrepreneurs. They just want to throw the money down. They won’t want to go through a filing process. The JOBS Act makes it too complex for different sides to participate.”

He isn’t the only Canadian who is skeptical about giving away equity. Rachel Young, co-founder of Toronto-based start-up crowdfunding site StartupFuel, said fragmented equity investment can bog down a start-up early on. “Having a whole bunch of investors at the beginning can be frustrating.” She hopes to have launched her service in beta with 20 start-up companies by September. “There can be too many people to update or answer to. When you start getting into equity, those are the expectations that those investors will have.”

But at least opening up the rules for equity funding would provide options. As it stands, Canada is limited to the other models, and they, too, can be problematic.

Or consider licensing

“If you’re pre-ordering something today and you know that you need 180 days to raise the money, and then you have to do final design changes and get into a queue and book the manufacturer, you could be a year out before you come off the line,” said David Geertz, founder of Vancouver-based crowdfunding site Sokap.

Sokap’s entertainment-focused platform has a unique approach to the crowdfunding model: licensing. The initiative sells licences for the crowdfunded products to individuals or groups based on geography. Those licensees can market pre-orders to people in their city, and collect a percentage of pre-order revenue.

Pebble’s Migicovsky did it in less than half that time, albeit with some problems along the way. His company had raised US$375,000 in angel money after he graduated from U.S.-based start-up accelerator Y-Combinator in April. Then he decided to try crowdfunding for a thousand watches via Kickstarter. When the project went viral, it was forced to source Asian manufacturers when its original U.S. manufacturer couldn’t handle the volume.

“We posted an estimated ship date of five months between the time the project closed and our estimated ship date,” Migicovsky said. “Supply chain is still one of the most difficult parts of this project, followed by software.”

Successful campaigns

What makes a good crowdfunding campaign? “It depends on your capacity to deliver,” Migicovsky said. “It is usually best to crowdfund if you have demonstrated that you can bring a product to market successfully.” He had already produced InPulse, a watch designed to work with the ailing BlackBerry, before crowdfunding his Pebble watch.
Slava Rubin, founder of Kickstarter’s major rival crowdfunding site Indiegogo, allows Canadians to participate in his U.S.-based platform. He said that fostering a network is vital to the success of any campaign. “Each campaign reaches out to its own network,” he said, adding that the first 30 to 40 per cent of the intended funding will come from a network of friends and family, those people who are already known to the start-up’s founder.

“If you can’t get that 30 to 40 per cent you won’t be successful,” Rubin said. However, once a campaign reaches that threshold, start-ups stand a good chance of raising money from further afield. “On average, more than 20 per cent of contributions come from complete strangers,” he said.

Engaging that network is vital, and it takes flair, said StartupFuel’s Young. She will work on a rewards-based approach, but promises what she calls “experiential” engagement with donors. “We don’t want to see everyone just offering stickers, T-shirts, mugs and iPads. Those are so generic,” she said. “We want to see interaction and experiences, something so amazing that it will really compel people to contribute a higher amount.”

Creative approaches to crowdfunding open up many possibilities. Perhaps, for example, contributors could vote on key product features or even help design them. The wisdom of the crowd is legendary. For some forward-thinking start-ups and funding platforms, it’s time to take advantage of those resources.


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