Crowdfunding

On Friday I went to Minibar, the first to present was Charles Armstrong from Trampoline Systems on the practicalities of crowdfunding. These are my notes, they may not make complete sense, although they are reworked somewhat from what I took at the time. My advice: there may be inaccuracies and typos here, so if it’s important check, as always be especially careful with legal info. Enjoy :)

Crowdfunding works in a variety of ways but is difficult to set up legally. A research project for the Open Society Institute couldn’t come up with a way for it to work.

Charles describes himself as a ‘corrupted social scientist’. His talk was designed to cover how to finance ventures. There are four conventional ways: venture capital, angel investors, family loans and loan finance.

Loan finance is under used. There’s a fixation on venture capital (VC) in the tech world. VC is problematic. Venture capitalists insist on preference stock, different from ordinary stock. They usually want extra rights and extra protections, they’re taking a risk yes, but anyone else investing in your business do to, for example friends and family. Why should venture capitalist’s be different?

Venture capitalists will lure you with high valuations for your business. But they completely screw with your corporate governance and articles. For Trampoline their articles became 12 times longer once venture capitalists became involved. You also suddenly have to hire lawyers, of course there are bills associated. Venture capitalists also use stealth control.

There are all kinds of agendas that are connected with VC fund life-cycles. You’re tied into the life-cycle of the VC fund. He’s not saying venture capitalists are bad, but there’s not enough discussion of their drawbacks. The recession and what’s happened over the last couple of years has had affects that some people think means VC funding won’t exist in the same format in five years time. They’re investing in fewer and larger deals. They’re focussing on seed and post-breakeven businesses. This leaves a large swathe of businesses not covered by VC.

What is crowdfunding?

The name comes by applying the concept of ‘crowdsourcing’ to that of money. It’s based around using the internet to build a much larger group of private investors. It’s a shift to a much more transparent form of investment (normal VC is very secretive). With crowdfunding everything goes into the public domain.

The concept of crowdfunding came from the early years of the 90s. The first wave started with the music industry. Sellaband.com and BandStocks.com are examples of crowdfunding. An artist puts themselves on the site and fans get a share of the proceeds if they make money. This works well in the film and music sectors where fan bases already exist.

The second wave (of which KickStarter.com in New York is one) was in the non-profit world.

The third wave was based on journalism. Conventional journalism was in decline. Spot.us is a site where journalists pitch ideas.

Trampoline started with VC funding and raised $6m in 2007. They realised it wasn’t a good time to bring in VC funding so they looked for alternative ways to do it. They spoke to their solicitors about crowdfunding, but lawyers don’t like innovation. The legal sector is based on precedent, their solicitors simply said crowdfunding is illegal.

Instead, they found a lawyer who wasn’t dismissive. Francis Irvine does work with the Open Rights Group, he likes innovation. After two months of scratching their heads, they found a legal way to do crowdfunding. They set themselves a £1m target to raise within a year. They’re doing it in a few tranches, they’ve closed their first and the second will close in the Spring.

This method of funding is not mainstream yet, but it will be. However it’s not for the faint hearted.

Benefits

They’re not victims to the VC fund life-cycle. They have a much bigger pool of influential people (investors) that will make them successful (Trampoline is only just seeing the benefits of this). Some would think having so many investors/voices would be a nightmare? However, arguing with investors is good, it challenges your ideas.

It’s not widely known, but the UK Government runs an Enterprise Investment Scheme which is unbelievably good. Wealthy people get 20% written off their tax bill and are covered for 60% of ther investment if the company goes bust.

The FSA is a nightmare though. If you get it wrong you are personally liable (not the company). It’s not easy to get started, you need to work your networks hard, do due diligence and speak to a lot of people. The Trampoline website has a few case studies. However you won’t find any content inviting people to invest on their site, they have to stay within the law.

Questions

Q. There seems to be a bias towards rich people. In the FSA regulations, if you’re seeking investment you can’t advertise it to the world (this protects the grannys). The FSA says you need to be a high-net-worth individual or a sophisticated investor to do it, but Charles how do you do it?

A. It’s illegal with a private company to incite people to invest. However, journalists can say anything they want. Journalists are your friends. You still need a website, but Trampoline’s is full of case studies. There are still exclusions: high-net-worth means £300,000 in net assets not including their main residence. You can tell these people or someone who works in the finance industry (a ‘sophisticated’ investor) that you’re looking for investment. But even if you tell them, you still can’t give them a business plan. You have to set up a labyrinthine system to get them to the next step towards investment. Sellaband and BandStocks are not selling equity, trampoline are the first to do this.

Q. What type of person are we talking about as an investor? Who invests in you?

A. There are two categories. Either 3rd or 4th levels down in their network or friends (friends of friends). Also, people who’ve read about them in TechCrunch or some other publication, they’re often semi professional tech investors.

We traditionally assume that PLCs float their shares on the stock exchange, really they can give their shares to anyone, Charles is looking at ways to reverse engineer a public company to be crowdfunded.

Posted on Monday 1 February 2010.

Posted in marketing, notes, politics, social | 6 comments »