Are crowdfunding sites the real winners?

Last updated: 25th June 2014

For entrepreneurs who need funding for their projects or ideas but don’t have much pull with banks or private investors, crowdfunding has become a viable alternative so much so that countries such as the US and New Zealand are putting regulations in place around it. Canada, France and the UK are considering doing the same.

But the grassroots approach to raising money still lies outside the financial mainstream in Australia, and some analysts think a bit of regulation wouldn’t be a bad thing. The federal government’s Corporations and Markets Advisory Committee (CAMAC) recently released a report that lays out a regulatory blueprint for crowd-sourced equity funding that would better protect the funders, including limiting funders to $2500 per project per year and $10,000 per year for all crowdfunding projects.

CAMAC, which was slated to be abolished in the May 2014 Budget, also recommended that crowdfunders be provided a cooling-off period and other rights to withdraw their money.

Crowdfunding also known as crowdsourcing seems to be a hit in Australia, where venture capital may be harder to find than in larger markets such as the US. So far, it’s mostly been applied where funding is notoriously thin, such as music, arts, and performance projects. One of the world’s biggest and best-known crowdfunding sites, US-based Kickstarter. recently started operating here one of just five of its non-US locations (the others are NZ, the UK, Canada and the Netherlands).

Winwin for crowdfunding websites

Crowdfunding can get a project off the ground if the money comes through. But because the crowdfunding sites take a healthy cut of the funding that’s processed through their online platforms, charge substantial transaction fees and take no responsibility for the trustworthiness of the people seeking funds, they come out ahead whether or not the project ultimately succeeds (though no funding changes hands if the financial target isn’t reached).

Melbourne-based Pozible. which says it has become one of the top three [crowdfunding] platforms in the world, claimed to have received $US19,197,929 in pledges as of mid-April. Crowdfunding sites around the world aren’t accountable if a project flops and plenty do. But it’s the success stories that have made crowdfunding a growth industry.

Last year, two Brisbane-based video game developers used Kickstarter to crowdfund a game that was in mid-development after major game maker Sega closed its Brisbane studio. They aimed for $600,000 and ended up with almost $800,000 from about 15,000 funders around the world. More recently, two NSW fund-seekers who launched their project on Pozible exceeded their $10,000 target to fund a brand of Australian-made organic vodka.

The reward for funders was bottles of vodka, an invite to the launch party, and an Australian spirit tasting and cocktail making master class, depending on how much you gave (the range was $20 to $1000). The funding target was reached in April; the estimated award delivery date is June 2014.

Piece of the action?

Some overseas crowdfunding platforms offer funders part ownership of what they’re helping to fund otherwise known as equity. One local crowdfunding expert we spoke to, Steve Johns of the multi-national law firm Norton Rose Fulbright. says offering funders equity would be a step forward for Australian-based platforms.

It’s very difficult to crowdfund in return for equity in Australia, and this has limited the projects capable of being crowd-funded and the investors willing to invest in those projects, Johns says. A key purpose of any new regulatory structure would be to facilitate equity crowdfunding. If Australia doesn’t do this, it risks losing projects to countries where equity crowdfunding is permitted.

While the details of any new crowdfunding rules remain uncertain, Johns says protecting funders will be a central plank. Investor protection is particularly important as investors are likely to be unsophisticated and have limited financial resources, and companies are likely to be at a very early stage with little or no track record.

What regulation?

Regulatory steps for crowdfunding under consideration in Australia include:

• Limiting the amount a person can invest in a crowd-funded company over a particular period of time.
• Limiting the amount a company can raise via crowdfunding.
• Mandating disclaimers and warnings on crowdfunding platforms that highlight the risks investors face.
• Requiring crowdfunding platforms to verify the identity of the companies seeking funds.
• Requiring funds to be held in trust by the crowdfunding platform until the funding target is met.

Even with such regulatory measures in place, however, funders will not be fully protected. It is unlikely that any new regulatory structure will include specific requirements that the company deliver on promised rewards, says Johns. However, companies that seek crowdfunding are currently subject to existing investor protection laws.

Pozible versus Kickstarter

Pozible claims a funding success rate of 55% compared with 43% for Kickstarter, although the latter has funded significantly more projects. Music, art, film, video and performance are among the most funded categories on both.

Kickstarter claimed to have funded 59,880 successful projects as of mid-April, and hosted 77,521 unsuccessful ones. Sixty-two of the successful Kickstarter projects generated $1m or more, and the company has seen more than $1bn in total pledged to its projects. The top two most funded Kickstarter project categories by a wide margin are music, and film and video, with technology and dance the least funded. Pozible says it had hosted about 6000 projects as of April and received $US18,993,045 in pledges. It currently receives more than $US1m per month

Funding fiasco: ZionEyez

Kickstarter reports that 43% of the projects posted on its website are successfully funded. But successful project owners don’t always keep their promises to funders, as the ZionEyez case proved.

The promised reward for ZionEyez funding of $US150 or more was the finished product, a pair of eyeglasses capable of recording HD video.

But funders ended up empty-handed after about $US340,000 was raised on Kickstarter, and the project’s founders effectively disappeared. The original target was $US55,000, and Kickstarter takes no responsibility for what happened to that sum or the extra $US285,000 even though it would still have presumably taken a five per cent cut, plus transaction fees of up to five per cent, for each pledge.

Our rough calculations put Kickstarter’s share of the ZionEyez project at about $US17,000, excluding the transaction fees.

Beware the disclaimers

Crowdfunding sites may represent a new frontier for raising money, but it’s a frontier that imposes all kinds of terms and conditions on participants. Pozible’s terms and conditions run to about nine pages and include this sweeping waiver: Pozible has no control over the quality, safety, morality or legality of any aspect of the rewards listed, the truth or accuracy of the listings, the ability of project creator to sell rewards or the ability of project supporter to pay for rewards.

Such language leaves funders wide open to scams, although Pozible spokesperson Natasha Duckett argues this is an incredibly rare occurrence. She says the platform will act as a mediator and contact any campaigners who fail to fulfil their rewards if we receive a complaint. If this remains unfulfilled, we will pass the crowdfunder’s details onto the pledger, who can contact the consumer authorities and make a formal complaint themselves.

While Pozible won’t take ultimate responsibility for the behaviour of fund-seekers, we require anyone who establishes a campaign to scan their photo ID and supply us with contact details, Duckett says.

Safety check before crowdfunding

Pozible told us it doesn’t have an official safety checklist for funders, but recommends consumers consider the following before pledging:

• Has the fund-seeker clearly explained what they will do with the money if they reach their target?
• Have they been clear and transparent in their campaign message?
• How have they responded to questions about the project on social media platforms?

A healthy cut for Pozible and Kickstarter

While crowdfunding sites don’t take responsibility if promised funding rewards aren’t delivered, they do take a hefty cut of the funding pie if the funding goal is reached. Pozible spokesperson Duckett told us that if a campaign fails to meet its funding target, we will not process any transactions or take any moneys put towards the account. The same is true of Kickstarter.