Crowdfunding is changing the approach to innovation

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IT and businesses that depend heavily on technology and the Internet play a disproportionate role in the economies of regions such as North America and Western Europe, contributing (on average) 3.4% of GDP (www.mckinsey.com/insights/mgi/research/technology_and_innovation/internet_matters) and 21% of GDP growth during the past five years in mature countries.

Venture capital traditionally has been one of the important sources of funding for start-ups in this area, characterized as they are by uncertainty and higher-than-average levels of risk. However, venture capital funding has been in a state of steady decline since the boom years prior to the “dotcom” crash, and this situation has not been improved by the current global economic conditions.

Difficulties in raising funds, and an extension of the time taken to successfully exit and realize a profit through initial public offering (IPO) flotation or acquisition, are cited as the causes. With fundraising at a low point, any significant and early rebound in investment levels is unlikely during the next few years. Nevertheless, venture capital funding in the US amounted to more than US$25 billion in 2011, according to PwC.

This decline (together with a sharp decline in the willingness of retail banks to extend credit lines to small businesses) has been a contributory factor in the rise of a new form of startup funding, crowdfunding, which leverages the growth of social media and the Internet — critical components of the Nexus of Forces identified by Gartner (see “The Nexus of Forces: Social, Mobile, Cloud and Information”). Crowdfunding, which exploits social connections to solicit investments from individuals, bypasses the traditional financial markets, although it is now expanding (where financial securities regulations permit) to also allow the sale of equity stakes via the same route.

According to one recent report, the number of crowdfunding sites grew by 60% in 2011 (to more than 450 worldwide) and raised US$1.8 billion in funds (see http://www.nesta.org.uk/home1/assets/features/%20the_venture_crowd).

Perhaps the best-known site, Kickstarter, had (as of 12 September 2012) raised almost US$300 million to fund almost 30,000 projects. Kickstarter is a binary environment; projects that fail to attract sufficient support to reach their funding targets within the time scale receive nothing. Two out of three successfully funded projects (overall success rate is 43.88%) sought between US$1,000 and US$9,999, while 10 projects raised more than US$1 million, and a further 259 more than US$100,000.

Crowdfunding is discrete from the microfinancing and social lending initiatives that have proliferated in emerging markets (although not exclusively). Sites, like Kiva, provide small loans (average approximately US$400) to individuals to assist them in becoming self-supporting. To date, Kiva has loaned a total of more than US$350 million to over 1.2 million individuals, with the funds being provided by more than 860,000 people.

In parallel developments (but equally significant in the overall evolution away from traditional approaches to business) are the emergent Web platforms for distribution (such as www.etsy.com), for product development (such as www.quirky.com, which shares sales revenues among contributors), for innovation (such as www.innocentive.com) and creation (such as www.topcoder.com). Collectively, these (and a variety of similar platforms) offer a new generation of entrepreneurs a way to circumvent the closed ranks of traditional businesses to create potentially disruptive, fast-growing competitors that can threaten existing incumbent organizations.

The views expressed here are the personal opinion of the columnist.

Photo credit: Flickr user Ben Heine

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