The concept of crowd sourcing or funding being the new source of funding has been bandied about for a while. New legislation is being considered in a number of jurisdictions making the crowd sourcing a more viable funding source.
The concept definitely has some good applications to new businesses and is filling a hole in a market that has moved to bigger is better. The main issues with crowd funding are:
1. It only appeals to investors in certain types of businesses.
It is understandable that those businesses that are more tech savvy are the ones that are getting the attention. From Kickstarter stats 22% of the business that successfully raised money were in the games sector and the next largest (21%) were film & video. This isn’t surprising but to get back to a bit of economic theory is it going to represent an efficient use of a limited capital base if the rest are locked out. The contra-argument to this of course is that current fundraising sources lock out most businesses – my point being there is no perfect answer.
2. Can it replace equity
Apart from donations where it is clear no financial return is expected by an investor (for want of a better word), the reality of crowd sourcing or funding is that at the current time it is a pre-sale of your product. Therefore, if your funding needs are only the working capital needed to get your business off the ground then this will work (if you meet all you cost projections).
However, if it is true equity you need for example if a large capital investment is required, the profits from the first lot of sales won’t get you very far or even started. In these circumstance equity investment is required with a return deferred to some point in the future when the business is successful.
What this would involve is changes in the law in Australia for one. At the moment there are thresholds where you can raise less that $2 million from less the 20 people in 12 months and not have to issue a prospectus (a costly exercise). The US is moving in the right way to look at simplier rules where crowd sourcing can be used to raise equity.
To me it seems practical. People funding under crowd sourcing are taking a risk anyway so why not give them a return and the business is a winner as well. Some threshold around not the number of people but the $ amount per person (say $200 to keep with the 2 theme) and $2 million maximum would seem a good solution.
At the end of the day crowd sourcing is a return to the original concept of a share market where the a lot of small investors pooled their funds to get an economic return. Why not recognise crowd sourcing as an unregulated market and put in the necessary protections?
At the end of the day crowd sourcing is similar solution to the problem that lead to the establishment of stock exchanges. Recognosing that the businesses are smaller and limiting individual risk through the amounts that individuals can invest seem a good way to me to ensure that crowd sourcing continues to be a viable source of funding for new businesses.