Global crowdfunding expands as alternative source of finance

Crowdfunding websites helped companies and individuals worldwide raise US$2.7 billion from members of the public in 2012, an 81 per cent increase on the previous year, data showed on Monday.

As banks rein in lending due to tougher capital rules and greater regulatory scrutiny, crowdfunding, which originated in the United States as a way to raise money for creative projects, has expanded rapidly as an alternative source of finance.

Many websites now offer small investors the opportunity to earn interest from lending money either to individuals or small businesses, while others allow people to invest as little as $15 in companies in return for an equity stake.

Interest in crowdfunding exploded after president Barack Obama signed the Jumpstart our Business Startups, or JOBS, act a year ago to legalise equity crowdfunding, subject to new rules being agreed by regulators.

The market is growing, though it still pales in comparison to bank lending to small-and-medium-sized firms, which in the UK alone stood at £28.7bn in the first nine months of 2012 according to Bank of England data.

Worldwide crowdfunding volumes reached $2.66bn in 2012, up from $1.47bn the previous year, according to a survey by Massolution, a research and advisory firm specialising in the sector. That followed growth of 64 per cent in 2011.

Massolution predicted $5.1bn would be raised via crowdfunding platforms in 2013, with a greater shift towards funding new businesses and small firms rather than social projects, which are currently the most popular category.

North America accounts for the bulk of activity, with $1.6bn raised there last year, a 105 per cent increase on 2011.

One of the most highly publicised crowdfunded deals last year saw smartwatch maker Pebble Technology raise more than $10m through US site Kickstarter, 100 times its target.

Sites seeking donations for charity or funding for creative projects in return for non-financial rewards – such as merchandise, access to computer games, or autographed albums – raised a total of $1.4bn, Massolution said.

Funds raised by lending sites increased 111 per cent to $1.2bn, while equity crowdfunding, the growth of which has been limited by regulation governing selling shares to the public, was the smallest chunk, providing $116m.

As crowdfunding is relatively new, there is no data yet on failure rates or average returns on equity investments.

"It can be difficult to make returns investing in early stage businesses, but crowdfunding adds flexibility as it opens companies up to a broader base of investors who may not be investing solely for a return," said Liam Collins, policy advisor at Nesta, a charity which promotes innovation.

Offering investors "rewards" on top of equity stakes can ease the pressure on companies to deliver returns, Mr Collins added. Generous tax breaks in Britain for investing in seed stage firms also make equity crowdfunding an attractive option.

There is no Europe-wide regulation in place specific to crowdfunding websites and the United States is in the process of drafting rules that would govern the sector.

Massolution estimates there are 813 crowdfunding platforms worldwide, either already active or planning to launch.

Wall Street's industry-funded watchdog, the Financial Industry Regulatory Authority, is working with the Securities and Exchange Commission (SEC) to draft crowdfunding rules and has asked websites to voluntarily register with it as a first step.

The SEC needs to adopt rules before small businesses can sell securities to investors through crowdfunding.

"Equity crowdfunding has tons of potential but how regulators interpret it will be a big issue," said Mr Collins. "You will see a step change in the growth once regulation is introduced in the United States."

Britain is also looking at how best to regulate the sector. Two equity crowdfunding sites, Crowdcube and Seedrs, have already been approved by the financial regulator, while lending sites will be regulated from April next year.

* Reuters