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Working the crowd

Working the crowd

The way people invest in emerging businesses is undergoing a quiet revolution. In the past, an entrepreneur with a bright idea but without the resources beat a path to a sympathetic friend or relative with some spare cash. Failing that, they might have turned to their local bank manager in the hope of getting a loan.

These sources of funding tended to work on the whole – but they have some specific failings. Those who were well-connected and had rich family and friends found it easy to raise funds from people they knew. Those who had tried and tested – and often fairly conservative - business propositions, found it relatively easy to raise money from banks. However, entrepreneurs whose business ideas were more radical and did not have stellar connections found themselves up against apparently insurmountable odds.

Investors looking for riskier and more radical ventures only had access to a fairly small pool of potential ventures they could invest in. Some were willing to put in the time and effort required to expand that pool of potential investments by actively looking around for the latest new micro-businesses. In recent years, match-making services have appeared which link angel investors with start-ups. This approach can be rewarding, but it is also risky and can prove to be hard work. It also requires a reasonable chunk of money. If an investor is serious about this approach, they need to invest in multiple businesses with the knowledge that only about one in 10 will create a serious return – but that return could be very substantial.

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Given the limitations of the angel investing model, people have been experimenting with new ways of harnessing technology to help connect investors and start-ups. One of the most well-known models to emerge from these experiments has been crowdfunding. This is a system whereby an entrepreneur raises start-up funds through soliciting small investments from a large number of funders. Often they do this through an online platform such as Kickstarter.

There are two major forms of crowdfunding. The first is rewards-based, where funders simply pledge to buy a product or service before it has actually been created. This is very attractive for entrepreneurs because it can help to build an order book, or, more generally, show there is interest in a product or service before it is actually produced. Rewards-based crowdfunding can be a great way to test whether there is actually interest in the products or services of a new venture before it is even pursued.

The second major type of crowdfunding is equity-based. This approach involves the entrepreneur selling shares in a fledgling venture to a range of backers. This is often a useful way for entrepreneurs to test investor appetite, but also, crucially, to raise capital. In recent years, some new forms of crowdfunding have begun to appear. These include debt-based crowdfunding, where individuals lend money to ventures, and litigation-based crowdfunding where people pledge money to fight a court case (and may gain some of the proceeds back if there is a win).

Despite being fairly new, crowdfunding has become increasingly big business. Last year, a report by Nesta – an independent charity that encourages innovative businesses – found that the UK crowdfunding market was worth about £112m, and growing quickly. Equity-based crowdfunding was growing by 410 per cent and rewards-based crowd fund was growing by 206 per cent each year. While many well-known crowdfunding platforms are based in the US, the UK has been a pioneer in the sector. Zopa, one of the oldest and largest peer-to-peer lending services in the world, is based in the UK. It has been operating since 2005.