The Looming Crisis for Crowdfunding – Why it is a Good Thing

Crowdfunding, where you put up an idea for a project and ask people from all over the world to back it with a pledge from their credit card is all the rage at the moment but it will experience a disaster in the near future. That disaster will not kill the value of the system but it will cause a re-organisation and re-evaluation of value.

As an example of the system I have backed a crowd funded project here in Melbourne for the Scanbox (http://www.kickstarter.com/projects/limemouse/scanbox-turn-your-smartphone-into-a-portable-scann) which is a portable box that folds down flat when you travel and stands up with small magnets when you set it up. You can place your phone on the top and it acts as a stable platform for taking photographs of receipts and documents up to A4 size. While you can already do that with your phone in your hands the photos can tend to be a bit blurred which causes problems with optical recognition systems and search. The project was designed by Lime Mouse (http://www.limemouse.com/) an app developer in Melbourne. They asked for $12,500 but raised $189,499. I have been giving Scanboxes away in my conference presentations and workshops for the last 6 weeks or so as a “prize from the future” and they have been so popular that I had to increase my level of backing to give more away.

In practice what happens is that people back a particular project and receive a reward related to the level of funding they have committed. This reward may be in product in the case of a music album or a new product, or it may be in recognition for community or environmental projects. This means that beyond raising money it is a great system for testing markets and support for ideas. If lots and lots of people love your idea and commit to taking product from you then you have tested the market in the best possible way – actual buying commitment rather than focus groups and market research questions.

Until recently you could not raise share capital on these systems here in Australia you can in Europe and the recent JOBS act in the USA is allowing that to occur in limited and controlled ways and that change is likely to spread. The system is going mainstream with the Australia Council for the Arts running a crowdfunding road show in July and August to show people how to use the system. (http://www.australiacouncil.gov.au/events/2012/crowdfunding-seminars)

There has been huge growth in the last 6 months alone. I presented on crowdfunding as an option for the Daimler Financial Services Asia Pacific leadership team for financing car sharing systems in February. At that time the largest crowdfunding site in the world Kickstarter had not had a single project that had raised $1 million. By the middle of June there were 7 projects that had raised over $1 million, including musician Amanda Palmer who raised $1,192,793 for a new album, book and music tour, and Pebble which raised $10,266,845 for an e-paper watch that connects to your smartphone. The Economist reported in June that research firm Massolution was forecasting US$2.8 billion will be raised this year compared to US$530 million in 2009 (see chart).

 

 

Via: http://www.economist.com/node/21556973

In addition to market testing and fundraising the crowdfunding system is also changing the way that business models work. It is allowing musicians like Amanda Palmer to go their own way, outside of the standard music industry structures. Other musicians are using it to plan tours by committing to go to places that promoters would otherwise not even look at. In the future I can see venture capital firms that have high levels of trust and high profiles allowing their initial backing of projects and companies to then be used to influence people to back that company. That would increase the power of the entrepreneurs along with the influence of the best venture capitalists.

But there is a dark cloud among all this silver lining. There will almost certainly be a major financial or project scandal on one of the major crowdfunding sites in the near future. Those of you who have read my other articles will know that I don’t really believe in forecasting, so you may be asking yourself why I am making this prediction. The reason is the only sure fire way I know how to predict things is by looking at long standing human behaviour. If you had asked me 20 years ago what would dominate large sections of the internet I would have responded with gossip, gambling, pornography, and crime because humans have been carrying out those activities for thousands of years and would continue to do so on a new platform. People have been having wild and crazy ideas and scamming people for thousands of years, therefore it is highly likely to happen in a crowdfunding situation. What will happen is that an idea that is being promoted will not come into reality and therefore people will not receive the product they were promised, or someone will run off with a bucket load of money. That will generate huge publicity.

That disaster will re-shape how crowdfunding works with trust being a key determinant of success. The perceived increase in levels of risk will mean that funding will flow more towards those people with a strong track record, or with some sort of other validation from a trusted individual or organisation who would not risk their reputation or brand in a problematic venture. Over time this will strengthen crowd funding, and personally I would like to put my trust and money in the hands of an open and transparent system like crowdfunding than in the hands of bankers and traders given their track record in the last few years.

 

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