Life
1 Mar 2012

The in crowd: crowdsourcing here to stay

A vital source of funding for businesses and a golden opportunity for small investors, or a scam of epic proportions? Whatever you think of crowdfunding it’s here to stay, says Nick Martindale, and the financial industry should be ready

CrowdsourcingThere’s little doubt the internet and social media have made it easier for individuals to interact – with positive and negative results. Now more businesses are interacting with the crowd, using the input of the masses to help research ideas, source labour, shape and even finance the future direction of their organisation.

One of the more impressive crowdsourcing tales involves Canadian mining company Goldcorp, which was struggling to find gold in northern Ontario. A new chief executive released its geological data over the internet, offering $500,000 to anyone who could help and the business found supplies worth $3bn. It became one of the world’s leading mining companies in the process.

Other examples are more mundane. Elliot Newsome, managing director of SKT Consulting, uses Prizes.org, run by Google, to source information and advice from the masses. “I use it quite a lot for technical support,” he says. “Time is important to me. Rather than browse the forums, I put something on there and it gets solved within a couple of hours.”

In its original form at least, crowdsourcing involves using many people to openly collaborate or compete on a project. Freelancer.co.uk recently introduced a crowdsourcing concept for design materials such as logos or brochures, enabling organisations to invite bids from designers based around the world. It allows individual suppliers to see other entries and adjust their own in line with feedback from the customer.

Its UK country manager Saif Bonar says the main benefits for businesses are access to a greater pool of talent and a much more cost-effective way of using this. “You can get hundreds of designs, then pick five or six and work with those,” he says. “It’s an incredibly effective way to tender a relatively low-value project.”

Katarina Skoberne, managing consultant at Katarina Skoberne Associates, set up Openad.net, one of the world’s first crowd-sourcing ventures – back in 2003. The business eventually folded but not before many firms had used it to source creative advertising concepts from all over the globe.

Interestingly, the business found that customers used it for other purposes than the one for which it was originally intended. “A lot of the advertisers used it to understand the creative perception of their brand, rather than use the advertisement itself,” she says. “They would get a wide perspective of responses to understanding their brand, and use that as a research facility.”

Yet there are concerns around the use of crowdsourcing from a business perspective. According to Tom Frederikse, a partner at Clintons Solicitors, it is fraught with danger and leaves businesses open to the prospect of infringing copyright. “How do you have any idea that the song, article, photograph or video is original?” he asks. “And if it turns out you were sold a lemon, are you going to be able to find the guy in the crowd to go after him? If you do, what if he has no money and you have to pay all the money to the original person? You might as well have gone to them first.”

Stan Lepeak, director of global research in KPMG’s management consulting group, based in the US, points to dangers in letting sensitive information into the public domain.

“Are you going to lose your intellectual property?” he asks. “There are some very serious issues relative to data privacy, particularly in Europe. When you look at smaller projects these issues are risks you can bear; when you start to look at more serious issues like developing systems around customer data you need to be very sure that there’s no back door left open.”

Bonar, though, believes issues regarding quality control and trustworthiness of suppliers can be overcome by applying the same kind of due diligence that would be enforced were the project being put out to tender in a more traditional manner. “You can look at a supplier’s feedback and ratings, check their previous work, ask for references and try to build up a rapport in the same way as you would in the real world,” he says. “Even though you may be getting something for a tenth of the price, it doesn’t mean you should put in a tenth of the effort.”

Facts in figures

90 - The optimum timespan of days for a crowdfunding campaign

£76bn The amount banks said they were committed to lending SMEs in 2011

50% The amount of income tax relief for people investing up to £100,000 a year in a qualifying start-up from April 2012 (SEIS)

For some businesses the real attraction of crowd power will come in the ability to source funding, usually as an alternative to bank loans or angel finance. In the UK, this approach has been spearheaded by Crowdcube, formed in 2010 by two entrepreneurs who had experienced difficulties accessing bank finance, and who successfully sourced £300,000 from 162 investors over a 10-day period in December.

“Seed finance for early-stage and growing businesses hasn’t really changed much in the last 150 years, going back to the industrial revolution when entrepreneurs would go cap in hand to wealthy people,” says Luke Lang, Crowdcube marketing director and co-founder. “We thought there had to be a better, fairer way of doing it. Rather than pitching to wealthy individuals you can pitch it to a nation of armchair investors, and enable anyone to invest in your business.”

The rules of investment are relatively simple; entrepreneurs must be from limited companies and receive all of what they request or pay back any money raised, while investors will receive shares – although not necessarily voting rights – in the entity which they are backing. The business has also attracted interest from more conventional lenders with gaps in their current funding options for small firms, says Lang, and has developed a partner programme for established independent financial advisers.

Inevitably there are doubts over the concept of inexperienced investors pledging money to businesses based on claims made over the internet.

“You could end up with boiler-room operations where it’s not dissimilar to asking people to give their credit card details or meet up with a benefactor to make their fortune,” says Lepeak. “Those risks could become significantly expanded if this becomes more common.”

Entrepreneurs, too, could be at risk of individuals coming forward years down the line and claiming they have a stake in the company, or face difficulties should they want to sell the business. “As the pot grows people will get more aggressive and lawyers will get involved,” he warns. “You may find that the loosely defined agreement you had a few years before doesn’t hold up.”

David Grahame is chief executive of LINC Scotland, the country’s national business angel association. He has a number of concerns, including the logistics of dealing with hundreds of shareholders when the business reaches the point at which it needs to seek more established finance, and the lack of expertise which an entrepreneur would normally expect to gain from a business angel.

Perhaps most worrying, though, is his suggestion that as individuals are unable to negotiate the price with the entrepreneur, they could end up losing out further down the line. “If there is another funding round and the business brings in a venture capitalist or angel syndicate it’s almost inevitable there will be a downvaluation at that point and investors will get squashed,” he says.

Crowdfunding is better suited to instances where equity is not involved, he suggests, such as where backers effectively buy products in advance or individuals pledge donations to social enterprises without expectation of financial returns.

For his part, Lang points  out that individuals do not need to invest if they do not like a valuation but admits that negotiation of equity is limited at present. “An entrepreneur can increase the amount of equity that they are offering, thus improving the deal for investors, but not reduce it,” he says. “Such a change in valuation would affect the whole crowd of investors and cannot be negotiated on a per-investor basis.”

Ultimately, though, he believes the onus is on the rest of the financial world to catch up with the new generation of funding. “Crowdfunding will become an established method of raising finance and institutional investors will need to evolve, to accommodate such emerging models in the future” he says. “We are confident we can structure deals to mitigate the risks of having a large number of investors.”

It is perhaps this view that echoes loudest, especially if the history of company email and social media usage is anything to go by, meaning this is an area of which the financial community at the very least needs to be aware.

“Crowdsourcing and crowdfunding are here to stay,” says Skoberne. “As with many innovations, they might be used differently to what was originally foreseen but they are contemporary instruments that will be leveraged. How they will structure that interaction remains to be seen, but there’s no way businesses can ignore the crowd.” 

Case study: funding down the farm

Community interest company BigBarn initially looked for £60,000 as it sought an injection of fresh capital and a means of spreading the word about its initiatives to encourage local farm produce.

“Everything we do is in the interest of the producers on our map and consumers using the website, so it seemed to make sense to get these communities involved by offering them shares,” says managing director Anthony Davison (below). “If we had 100 consumers investing they would become advocates and tell their friends. That was as important as the money side.”

The first attempt was unsuccessful. Davison puts this down to the fact that turnover had been steady but not spectacular over the company’s 10-year history and that, as a community interest company, it would be unable to float in the long term. “You want a quarter of the money you need already pledged before you start,” he adds.

Eventually BigBarn ran a second event looking for £12,000 from those who had expressed interest in the first attempt in return for a 4% stake, which Davison says was achieved comfortably. He’s also talking to more conventional business angels.

“I didn’t do it quite right,” he says. “But it provided us with a fair bit of PR and it’s quite a cheap way of raising money.”

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