Start-ups will play a vital role in driving the economic recovery from COVID-19, says Rob Phillips.

The importance of start-ups to the economy has been hammered home by a number of organisations and industry bodies, including in recent reports from the Organisation for Economic Co-operation and Development (OECD) and several major banks.

Indeed a landmark 90% of businesses worldwide are SMEs, representing 50% of all jobs globally, according to the World Bank. The organisation estimates SMEs will have created 600 million new jobs worldwide by 2030 alone.

But with debt and equity funding hard to obtain for early-stage businesses, and with limited government funding available in the UK, many have turned to crowdfunding to kick-start their projects.

Global market

The global crowdfunding market is growing rapidly. In 2020 it was estimated to be worth $100 billion, a figure expected to double by 2026, with the UK alone representing approximately 10% of this market.

Take the Kickstarter platform as an example of rapid growth. As one of the most popular funding platforms for creative projects worldwide, the site has just reached the milestone of $6 billion in total funds raised since its launch in 2009.

The platform has provided many start-ups, including the Star Citizen video game, with multi-million-pound sums to scale. It has also backed many small-scale projects, such as actress and producer Phoebe Waller-Bridge’s TV series Fleabag, which have gone on to become household names. Many blockchain-based projects have also raised significant funding in recent months, a trend which is likely to accelerate in years to come.

Different types of crowdfunding

Crowdfunding involves raising small sums of money from a large audience to fund a project or venture. To attract donations, start-ups create a pitch - often using a video - and upload it to a crowdfunding platform where visitors can pledge money to the project in return for a reward.

Rather than persuading one major investor to take a big risk, start-ups hope to attract many small investors, who often risk as little as £5 in investment. This can lead to businesses being funded quickly by spur of the moment decisions by investors, based on appealing to their gut instincts.

There are four main types of crowdfunding:

• Equity - investors become a ‘mini-dragon’ owning a small share in the project. Platforms that support this style of crowdfunding include Crowdcube, Seedrs and Companisto, where innovative and high-tech businesses often pitch.

• Debt (otherwise known as peer-to-peer lending) – this type of crowdfunding is the most popular, and works best for relatively safe projects. Investors are repaid with interest, often at around the 6-8% mark, and well-known platforms offering this type of crowdfunding include Funding Circle, which has lent more than £11 billion to 100,000 businesses to date, as well as Lending Club and Zopa.

• Donation - donors can invest simply for a “thank you”, but this only really works in the case of not-for-profit social or community projects. Platforms such as GoFundMe, which recently topped $9 billion in total investment raised to date, use this model.

• Reward - the reward model, as used by the Kickstarter and Indiegogo platforms, allows founders to offer rewards to investors. This approach was initially used by bands who gave investors free music downloads and gig tickets, but it also works well in many creative industries, such as those with video games who can turn an investor into a character in their game.

Ingredients for success

A transparent pitch is a vital component of a compelling crowdfunding campaign, and using video to communicate the back story of the business or project doubles the chance of its success. Much of crowdfunding is local, despite the potential to collect investors worldwide, so communicating a clear identity for the project that will resonate with a local audience will help.

Setting a realistic funding target – around £30k is the average - and focusing efforts on a short campaign encourages immediate action from the target audience, rather than allowing people to go away and forget about it. A campaign that spans as little as two weeks shows that the founders are confident.

Unexpected challenges

For any founders that don’t manage to reach their target, platforms often won’t allow them to access any of the funding they have achieved in an all-or-nothing scenario.

Founders must also be careful that any rewards they are offering to investors as part of the crowdfunding process do not outweigh the investment given. Spending late nights making personalised rewards such as artwork take valuable time and resources away from the business.

It’s also crucial to advertise campaigns via social media and PR to stand out from the pack, and drive people to a pitch. It can be a stressful process with many days of little activity but it’s important for founders to remember that momentum often builds late in a campaign and most of the action will likely only happen close to the deadline.

Reaching targets

Sometimes projects gain many times more than their original target. When a target is reached, it encourages more people to invest for fear of missing out. If founders get more than expected, then they can set ‘stretch goals’ which outline what they will do with the extra money to enhance the project.

The more transparent the pitch, and the better founders are at reducing information asymmetry between investor and founder, the more likely they are to receive investment. But the potential drawback is that it makes it easier it for copycat projects to emerge. Added to this, if a project never reaches its target, investor fatigue can see fans lose interest in the idea.

If founders are prepared to put in the work, the success rates for crowdfunding campaigns are surprisingly high with approximately 25% of projects getting fully funded. Kickstarter suggests 39% of projects on its platform get fully funded, and with data suggesting crowdfunding is most popular with 18–34-year-olds it’s certainly a popular route for student and alumni founders.

Written by

Rob Phillips

Senior Lecturer

Masood Entrepreneurship Centre

The University of Manchester