Crowd funding proves fruitful for small and start-up businesses

IT BEGAN when a group of fans of rock group Marillion raised $60,000 on the internet to underwrite a US tour. Now “crowd funding” is becoming an established means for small and start-up businesses to raise early-stage finance.

A group of graduates from the University of Edinburgh are the latest to raise £10,000 direct from individuals for the acquisition of a wholefood shop in the city.

The Edinburgh Wholefood Cooperative expects to meet its target of £45,000 to relaunch the New Leaf wholefood store in the city’s Marchmont district as a worker-owned co-op next month.

Investors with more than £10 to spare can loan it to the co-op for seven years through a platform called Bzzbank. Bigger fish who chip in £500 or more receive loan stock – which offers interest rates of up to 4 per cent on investments for five years.

After Marillion fans got the crowd funding idea under way back in 1997, the concept was adopted by charities, through sites such as Justgiving and ­Indiego-go. But it has really taken off in the US and the UK since the banking crisis which saw traditional sources of funds dry up.

There are three main models for people to raise money, all using social media platforms and websites. The first is the “reward” or pre-sales model. Funding is an up-front payment for a product or service and is often used by musicians, authors and film-makers.

It has evolved to include peer-to-peer lending, where investors are promised their money back after a certain time period.

There is also an equity model, where investors are buying a share in the concept or business being funded similar to that used by business angels.

This evolution has meant that it has become increasingly professional. Last year, three of the largest peer-to-peer ­finance platforms, Funding Circle, RateSetter and Zopa launched the first trade body in the sector, the Peer-to-Peer Finance Association.

But as more companies turn to crowd funding and other alternative sources of raising finance, there is a growing need for proper protection for investors. It has now come under the scrutiny of regulators. In March, the concept was acknowledged by Andy Haldane, the Bank of England’s executive director for financial stability, as a potential rival to traditional banking.

He said: “Commercial peer-to-peer lending, using the web as a conduit, is an emerging business. With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middle men may in time become the surplus links in the chain.”

In April, equity crowd sourcing platform Seedr became the first to be authorised by the Financial Services Authority. However, the regulator last week published a warning for potential investors, as the majority of schemes, like the savings vehicle Farepak which collapsed owing members millions, do not offer investors recourse to the Financial Services Compensation Scheme if things go wrong.

Michelle Rodger, the co-founder of Scottish crowd funding platform BloomVC, said it does not require FSA authorisation because it does not hold funds, although others do. Instead BloomVC arranges for the money to be taken from donors’ accounts when the fundraising is deemed successful after 30, 45 or 60 days.

“We are an all or nothing model – if you don’t reach your target you don’t get anything and we don’t get our five per cent commission,” says Rodger. “Crowd funding is so new in the UK, we wanted to make it as simple, as easy and as safe as possible for people.”

The company has had 40 projects on the site – currently there are eight live funding projects, and nine have successfully closed.

Sophie Preston, 27, a member of the Edinburgh New Leaf project, said: “We chose crowd funding because we believe it is hard to get funding from the banks at the moment and the interest rates we would get would not be particularly favourable. Another aspect was we see it as a community project. We saw it as a way to get the community involved and invested in the project.”

She said the company did not approach a traditional lender. “We didn’t try to go down the banking route because we thought we’d give Bzz­bnk a go,” she said.

Martin Meteyard, the lead delivery partner for the Co-operative Enterprise Hub in Scotland, helped the Edinburgh Wholefood Cooperative develop its business operation. The co-op offers its crowd funders benefits when they shop at New Leaf, including free coffees and discount vouchers. It was the first time he had been involved in a business raising money through crowd funding, but he thinks the appeal will grow.

He said: “Crowd funding allows you to reach out to a wider community. I’m sure we will see more of it in the future.”

HOW IT WORKS

Reward or pre-pay:

In 2009, Kickstarter launched a platform to support creative projects. In 2010, the Lunatik/TikTok watch raised £600,000 setting a crowd funding record.

Peer-to-peer:

In 2005, Kiva launched the first platform to allow entrepreneurs to lend money to developing areas across the world. The model expanded into an alternative to traditional bank lending with the launch of Zopa, Bzzbnk and BloomVC.

Equity:

In 2010, GrowVC and Crowdcube both launched equity-based crowd funding concepts for startups. In 2011, the Rushmore Group raised £1m from 143 investors in four weeks – the largest ever raised through crowd funding.