With trust in banks at an all-time low, growing numbers of engineering companies are turning to the power of the internet to raise cash and take their products through to commercialisation.
The new financing models are based on the concept of crowdfunding – where individuals contribute online to a company or even buy equity to support an expanding business. Hundreds of millions of pounds have been raised through crowdfunding since the trend emerged after the global recession, with websites such as Kickstarter, Seedrs and Funding Circle leading the way.
Crowdfunding started around ‘softer’ activities such as the support of artists by fans or the backing of political campaigns. But there is increasing evidence that it is now being used to support companies that make things. It is being seen as a much quicker means of securing finance than traditional methods such as going to banks and extending an overdraft.
And the concept can be used to test new ideas – some crowdfunded projects attract support from hundreds of investors, all of whom can be used as a sounding board when taking a product from concept through to design.
Kickstarter is perhaps the best known crowdfunding website. Since its launch in 2009, 5.2 million people have pledged $890 million, funding a total of 52,000 projects. Kickstarter has a distinct business model – backers support projects because they “believe in them”, says the firm, rather than because they want to profit from them personally. Indeed, Kickstarter cannot be used to offer financial returns or equity, or to solicit loans. Backers are typically rewarded for their support with products or gifts.
“A lot of backers are rallying around their friends’ projects,” says Kickstarter’s Justin Kazmark. “Some are supporting people they’ve long admired. Many are just inspired by a new idea. Others are inspired by a project’s rewards – a copy of what’s being made, a limited edition, or a custom experience related to the project. It’s not philanthropy, or commerce, in the traditional sense – it’s more of a value exchange. It’s an emotional transaction,” he says.
In the case of Kickstarter, every project creator sets their funding goal and deadline. If people like the project, they can pledge money to make it happen – the average donation is $71. If the project succeeds in reaching its funding goal, all backers’ credit cards are charged when the deadline expires. If the project falls short, no one is charged. Funding is all-or-nothing.
The breadth of technology-related projects that have been funded through Kickstarter is surprising. Formlabs recently attracted $3 million from 2,000 backers to launch an affordable 3D printer. A lighting company, meanwhile, secured $500,000 from 7,000 backers to progress a lamp design using passively cooled, blue-laser technology.
And an electrical engineering outfit raised a similar amount to launch a wi-fi-enabled, cloud-powered development board for internet connection. In each case it is the responsibility of the project developer to keep backers informed about progress and to decide on the specifics of the rewards.
One company that has used Kickstarter to good effect is New York-based FlyKly, which has been seeking support for its Smart Wheel, a pedal assist that encases an ultra-thin electric motor and intelligent electronics within a housing that can be neatly fitted onto the spokes of a bicycle rim. FlyKly, which employs 11 designers and engineers, spent 12 months refining its prototype and needed capital to set up production.
Smart Wheel: Feedback from potential investors led to design changes
FlyKly’s founder and chief executive Niko Klansek says: “We needed to raise money but we also wanted to use a business model that enabled us to gain feedback from potential customers. If you go down the venture-capital route, you often learn what the customer wants after you have started making it. But with Kickstarter we had hundreds of interested people telling us what they liked and disliked about Smart Wheel, and that helped.”
Indeed, this feedback led to several design changes. Klansek says: “Initially we were only going to offer two sizes of Smart Wheel – 26- and 29-inch diameter – for city and mountain bikes. But our backers said what about foldable bikes and BMXs? It was actually very simple to produce Smart Wheel in different sizes, so it was a good idea.
“Also, the process led to us increasing the number of types of brakes that were suitable on Smart Wheel, and to the development of a ‘glow in the dark’ wheel that is visible from both sides.”
The FlyKly campaign really caught the imagination of backers on Kickstarter. The company hoped to raise $100,000 from a 40-day campaign. Instead, it raised that amount in just a day and a half. In total, FlyKly raised $700,000 from 2,300 backers, each of whom will receive goods such as bicycle lights through to the wheel itself, depending on the level of their financial commitment.
Klansek says the money donated will help the firm to scale-up activities, enabling it to place bigger orders with suppliers. “The batteries will come from the Far East, but all other materials will be sourced from Europe and the US. We hope to start making Smart Wheel next May and shipping shortly after,” he says.
Klansek says that using Kickstarter was about more than raising money. “Finance was just one metric. Just as importantly, Kickstarter helped us create a market for the product. We have more than 2,300 backers, but they have shared information on the project through social media many thousands of times. That is a really important benefit of this approach.”
If Kickstarter thrives on backers having an “emotional investment” in the projects they support, other crowdfunding business models attract investors with the promise of more tangible rewards – namely cold, hard cash.
Funding Circle, for instance, is a peer-to-peer lending website that allows savers to loan money directly to small and medium-sized businesses. In return, investors get guaranteed percentage repayments.
Investors can browse businesses that Funding Circle has credit assessed and approved for lending. Once approved, businesses post their loan request on the Funding Circle marketplace. Here, investors choose which type of businesses to back and, through an auction process, bid the amount of money they wish to lend, and the interest rate they want to earn. Loan auctions typically take seven days. Usually lots of investors each bid small amounts on hundreds of different businesses, therefore spreading their risk. After a business accepts a loan, it makes one repayment each month which is collected by Funding Circle and distributed to investors.
Funding Circle was launched in August 2010 and so far 60,000 people have loaned a total of £180 million. The service is growing quickly – Funding Circle is currently lending around £16 million a month and recently won £20 million of additional loan funding from the UK government which is keen to support crowdfunding as an emerging way of supporting small businesses.
Typically investors risk small amounts – as little as £20, with 500-1,000 people participating in each auction. The average amount an active investor has in their account is £5,000, and the average net return is 5.7%.
Although Funding Circle credit-checks every business it works with, repayment failures do occur. The site supports struggling firms, and works with administrators to get as much money back from failed companies as possible. Funding Circle says the bad debt rate stands at 1.5%, which represents a low risk when investments are spread across many auctions.
In terms of what Funding Circle offers to businesses, the main benefit is competitive lending and a quick decision on funding requests. The entire process is handled online, with requests for funding agreed by Funding Circle’s assessors within 48 hours. The auctions need to be 100% funded to trigger investment, with Funding Circle claiming that most reach their targets, often within a couple of hours.
Some companies have used Funding Circle to good effect. Ambic, for instance, designs, builds and installs furniture and lockers in schools and colleges. The County Durham-based company employs 32 people and turns over £1.75 million. It has been profitable for most of its 30-year history, bar a couple of tough years immediately after the financial crash in 2008.
Ambic’s business is cyclical – its main customers are educational establishments which tend to be shut over the summer. So it needed working capital to get it through these months.
“We went to our bank asking for a temporary overdraft but the rate it offered made it impossible for us to borrow,” says Dave Potter, Ambic’s owner and founder. “We needed to look at alternatives, and considered crowdfunding.”
Ambic approached Funding Circle, requesting £100,000, to be paid back over 12 months. The company went through a suitability assessment interview and provided Funding Circle with three years of accounts. It was approved within 48 hours and the auction was fully subscribed within a matter of days. Within three weeks of its initial contact with Funding Circle, the £100,000 was in its account, to be paid back at 9.02% AER.
Ambic’s accountant Dave Richings says: “It was a pleasure working with Funding Circle. To be honest, compared with our bank, we were over the moon with the rate we secured. The process ran smoothly. We were really impressed.”
Ambic is now looking to expand, and will consider using Funding Circle to raise additional funds. “It’s a great alternative to mainstream banks,” says Potter. “The key to crowdfunding is being honest with the marketplace – as we were. If you are a legitimate business, it is a fantastic way to get cash.”
Looking to the future, Funding Circle says that crowdfunding is likely to emerge as complementary to more traditional forms of revenue raising such as private-equity investment. One of the main selling points of crowdfunding is the speed at which decisions can be made.
And Funding Circle thinks that, as the software that underpins suitability assessment and auctions is further refined, the whole process can become quicker still.
Computer sets pulses racing
Some Kickstarter projects catch backers’ imaginations to such an extent that they become runaway successes.
That has proved to be the case with a project to raise funding for a do-it-yourself computer, powered by a Raspberry Pi single-board device. The Kano computer has been designed as a simple, fun and easy-to-use toolkit that will encourage children to experiment with hardware and to start coding at a young age.The Kano Kickstarter project smashed its $100,000 target in just 18 hours. As PE went to press, some 7,500 backers had donated a total of $840,000.
Runaway success: The Kano computer
In return, those who have given less than $19 will get books and their name inserted in the source code. Those who have donated $30 will get T-shirts as well. And those who have given larger amounts will be sent the computer itself.
Click here for funding
There are several other crowdfunding websites that are successful in the UK. They have slightly different business models, based on either equity or product returns. Three of the most popular are CrowdCube, Seedrs and Indiegogo.
In the US, CircleUp has emerged as a popular website, specialising in raising capital only for companies that have reached $1 million or more in annual sales.
Research from consultancy Massolution shows that there could be as many as 800 crowdfunding websites worldwide, with North America and Europe accounting for 95% of the funds raised.