For growth-focused companies, crowdfunding has rapidly transformed from a niche market into a legitimate and viable form of alternative financing. Studies indicate that, from 2009 to 2014, the crowdfunding industry grew by an estimated 1,000%.1 At the close of 2014, more than 3,500 active crowdfunding projects were looking to raise over $20 billion in capital, according to data analytics company Dealflow.com. Research indicates that crowdfunding should flourish into 2015 and beyond.
The technology industry stands out as a major beneficiary of this promising method of capital raising. In 2014, technology was a leading sector in terms of capital commitments – at around $98.5 million – and led the number of raises that have been offered since inception, according to Crowdnetic’s Quarterly Private Companies Publicly Raising Data Analysis.2 Capital commitments in the technology industry trailed only behind the services industry.
So why has crowdfunding become such an attractive financing vehicle for technology companies? And what is required to launch a successful crowdfunding campaign?
Proving legitimacy and demand
Obtaining financing from traditional lenders such as banks, angel investors, and venture capital firms can be difficult for some early-stage technology companies. Crowdfunding offers an additional source for raising capital. Many investors are eager to support innovative ideas or services, and the growing legitimacy among accredited investors to provide financial backing through the internet has contributed to the popularity of crowdfunding. For tech startups, crowdfunding is an effective way to demonstrate to lenders the demand for a product or service and also to justify the company’s financial projections. Technology companies that have successfully secured accredited investors via the web are especially attractive to traditional lenders as their ideas have reached a level of legitimacy and approval.
Testing the markets and building brand awareness
In addition to raising capital, crowdfunding provides a platform for technology entrepreneurs to test the success of their product or service once it is officially on the market. Through this process, an entrepreneur can determine whether to continue investing time and money in a particular product or service based on feedback from potential customers. Doing so avoids involvement in a venture that may ultimately prove to be futile. The exposure of a product or service through crowdfunding offers the ability to build brand awareness and develop a loyal community of customers right from the start. Developing a loyal following can generate word-of-mouth advertising that can boost a startup business to success.
Finding success
There is a commonality among crowdfunding success stories. Deals receiving funding typically have outside sponsors who advocate on behalf of the deal. These are usually prominent investors who are willing to put their names on the deal and endorse them personally. This signals to other investors that it is a quality opportunity. “This is not so different from the way investments have always been done,” said Steven Dresner, CEO of Dealflow. “In the past, one prominent venture capitalist would put a million dollars in a deal, and then the startup could use that as leverage to attract more VC money. Now it is just taking place in a whole new forum.”
Because that forum is so public, it is extremely important for companies seeking capital to make a strong first impression. “If you have an unprofessional website, people won’t take you seriously,” said Luan Cox, CEO of Crowdnetic. “If you don’t have a nice investor deck, it becomes obvious very fast. So, as a private company, you need to get even more dressed up for the dance if you want to raise money from the crowd.”
What does the future of crowdfunding hold?
Notwithstanding its popularity within the technology industry, to date, equity crowdfunding may be best characterized as a “growing” source of capital formation available to private companies. But crowdfunding could rapidly accelerate if non-accredited investors are allowed to participate in these deals.
No doubt, crowdfunding has made it much easier for private companies to reach the estimated 3.4 million accredited investors in the U.S. Accredited investors typically have annual incomes of at least $200,000 and a net worth of at least $1 million. But the JOBS Act could eventually make it possible for non-accredited investors to participate as well. This could lead to a deluge of capital as millions of new investors enter the market.
Although the timing and likelihood of the passage of Title III of the JOBS Act remains unknown, if passed, privately held companies will be allowed to raise up to $1 million per year from the general public through equity crowdfunding portals. “If every American family gave just 1% of their investable assets to crowdfunding, it would be a $300 billion market,” said Cox.
Still, Cox admits that it will take a long time to educate the American public about the opportunity that is available to them. But, if and when that happens, the funding of private companies through equity crowdfunding sites could eventually be as common as investing in the stock market.
“Imagine a time when you can go online and see what the top venture capitalists or private equity professionals are investing in, and what you’re allowed to invest right alongside them,” said Cox. “That makes for a powerful shift in the market.”
What Does CohnReznick Think?
Entrepreneurs continue to test the market in determining how best to utilize crowdfunding as an alternative strategy for obtaining financing, gaining exposure, validating their products or services, and ultimately, expanding their businesses. The influence of crowdfunding on the middle market sector has yet to be fully realized. However, crowdfunding is on track to not only transform how privately held companies raise capital and interact with investors, but to also influence how businesses formulate and implement their go-to-market strategies.
Oculus Rift: A Virtual Crowdfunding Game Changer
Oculus Rift is a prime example of how crowdfunding can be a powerful tool for gauging the public’s interest in a product and testing whether there is a legitimate market for it.
A virtual reality technology company, Oculus VR launched its Kickstarter campaign in 2012 with the intent to further develop its Oculus Rift prototype – a virtual reality headset designed specifically for video games. Throughout the campaign, Oculus Rift garnered nearly 10,000 supporters who pledged almost $2.5 million – a mark that far surpassed the company’s original goal of $250,000. In 2014, Facebook purchased the company for $2 billion.
As one of the most successful rewards-based crowdfunding campaigns in history, the Oculus Rift story demonstrates that crowdfunding has the potential to help small businesses and entrepreneurs grow their businesses and spring-board to greater opportunities.
Contact
For more information, please contact Alex Castelli, partner and CohnReznick’s Technology and Life Sciences Industry Practice Leader, at 703-744-6708 or [email protected]. To learn more about CohnReznick’s Technology Industry Practice, visit our webpage, http://www.cohnreznick.com/insights/newsletters/crowdfunding-technology-takes-lions-share-of-capital-commitments#sthash.Tz20ElIs.dpuf.
