23 April 2013

A different audience: Designers look to crowdfunding to get their idea off the ground

Not so long ago, getting a business venture off the ground involved one course of action: grovelling to a bank manager in the hopes they would offer a loan or second mortgage.

Things have changed. About 20 years ago, the world of private equity discovered technology. During the 1990s, investing in technology funds began to look like a one-way bet. Although individual companies would often hit the wall before providing a return to investors, there would be enough high-profile, incredibly profitable, flotations to maintain high returns for the funds overall.

Web browser pioneer Netscape's initial public offering (IPO) focused public attention on the world of venture capital and its potential returns as the company's stock price rocketed on the NASDAQ exchange in the mid-1990s. That the market value of the company would plummet to Earth not long after was unimportant – early-stage investors made a handsome profit. And earlier IPOs of companies such as Altera and Xilinx showed that venture funding need not be isolated to internet software. Electronics companies were attracting investors on the back of the internet revolution.

Then the dot-com bubble burst. Although internet stocks such as Facebook have shown that IPOs can attract public attention even now, electronics companies have failed to regain their earlier popularity. Without high-profile, high-profit exits, venture funding into electronics has all but dried up. From hundreds of companies a year at the peak of the dot-com bubble, just a handful are now funded each year.

New approaches replace VC funding
Although venture funding has ebbed, other options have appeared. Some companies are using consultancy to help bankroll longer-term projects, sometimes in combination with smaller quantities of early-stage investment from the few venture funds that remain active or, more often, business angels – private investors with an interest in the technology sector.

Some organisations have attempted to fill in the gaps. EMAnetworks grew out of Cre8 Ventures, launched by Mentor Graphics to provide access to otherwise expensive EDA tools to start-ups through a revenue-sharing model. EMAnetworks goes further by finding customers for early-stage start-ups, who can provide funding on a risk-sharing basis, as well as reducing their outgoings by taking on some operational support and helping to connect developers with sources of IP from academia and other companies.

Another option being applied by a wider range of business ventures is crowdfunding. In effect, it opens up the use of customer funding to a much broader base.

The flurry of interest around the Raspberry Pi board has thrust the possibility of crowdfunding electronics projects into the spotlight. To finance development of the Eve platform for its wireless home automation gateway, Ciseco turned to crowdfunding. Ciseco opted to base its home-automation gateway around the Pi because, for its compute power, the Pi works out as incredibly cheap, especially for products that are not likely to ship in high volume.

Ciseco's choice of Pi also helped to raise the project's profile and to solicit advance funding. The company used Kickstarter, one of a number of websites that have sprung up over the past decade to act as a link between companies with ideas and potential customers. On Kickstarter, people pledge money in return for different levels of participation in the venture – such as advance access to a product or a simply a higher-specification product.

For example, Sheffield-based Pimoroni is building a collection of mini-arcade consoles around the Pi. People who pledged around £120 get a smaller version; those offering closer to £200 get the full version of the Picade when it's released this spring.

Some projects find it easier to raise funds than others. Ciseco had to do a lot of publicity in addition to listing on Kickstarter to get to the target amount. It took seven business weeks of drumming up support through forums and other online vehicles in what CTO Miles Hodkinson called a 'relentless effort'.

By the deadline, Ciseco raised 140% of its £15,000 target and has now completed the shipping of the Eve systems funded by the Kickstarter programme. Although raising money through Kickstarter was hard work, the company is likely to seek a second round on Kickstarter with a more modular design.

A common technique for raising money to a deadline is to have a sliding scale of packages with lower prices and better benefits for early adopters. For example, a $20 pledge for a DSP card built on an Arduino Shield offered by Connecticut based Douglas Lyon, developer and chairman of the computer engineering department at Fairfield University, was designed to give the first crowdfunders for his project the rights to one of the first assembled boards. Once the first 12 slots were gone, backers could choose the second package – again for an assembled board – but with a price tag of $25. In turn, that was replaced by a $35 assembled-board package.

Even chip design companies have started to try the model. Adapteva is a parallel-processor company founded by former Analog Devices TigerSharc engineer Andreas Olofsson. Initially, Adapteva had some direct customer funding to the tune of $1.5million from Bittware, which helped produce the first implementation of the architecture, a 16-core device build on a 65nm process.

The second version of the Adapteva processor, aimed at the 28nm process node, expands the number of cores on a single die to 64 and was developed in cooperation with GlobalFoundries. As part of the deal, the Adapteva architecture can be licensed by GlobalFoundries' other customers for use in their own ICs. Through deals like this, the foundry intends to widen the amount of IP that it can offer to companies that want to run products through its fabs.

To reduce development costs, Adapteva used multiproject wafer runs – which share the costs of a mask set, which would otherwise be prohibitively expensive at 28nm – to fab the devices. Although the use of a small part of the mask wastes much of the wafer, the much lower startup costs make it possible for companies on limited budgets to obtain silicon. If volumes ramp significantly, Adapteva expects to switch to a custom mask set.

Kickstarter funding for chip development
To try to expand its business, Adapteva decided to try to raise $3m through crowdfunding, also using Kickstarter. The company fell significantly short of its target, but still raised close to $1m from prospective customers who can expect to receive a computer board that carries one of the Adapteva chips in return for their $99 downpayment. The company expects to deliver the first of its Parallela boards in June.

The idea of crowdfunding through potential customers, rather than shareholders, is far from new, although it has largely been restricted to artistic projects. US fans of the rock band Marillion financed the cost of a tour across the country by raising $60,000. This remains one of the most unusual cases of crowdfunding as the band did not ask for the money to tour – the fans took it upon themselves to raise the money after finding out the band could not afford to take on the risk of doing a US tour and wait for ticket sales to roll in afterwards. Other sites in use today besides Kickstarter include Fundly, GoFundMe, Indiegogo and Microventures, among others.

In principle, crowdfunding dates back a lot further. It had its beginnings in the form of community lending. Jonathan Swift set up a scheme in the 18th Century that funnelled loans financed by a wide base of concerned investors to poor Irish families. Charity appeals for artworks and statues represent the first forays into the kind of model that organisations such as Kickstarter support. The Statute of Liberty in New York was only completed after an appeal by publisher Joseph Pulitzer to the American public. More than 100,000 people donated $1 or more each to finance the construction of the statue's pedestal.

In many countries, a funding model that assumes donations or pre-orders is easier to set up. The other model, in which companies offer share equity in exchange for money, is today much more tightly policed by institutions such as the Financial Conduct Authority, formerly part of the now disbanded Financial Services Authority, in the UK and the Securities and Exchange Commission (SEC) in the US.
Flotations on public stock markets are expensive, partly because of the legal obligations companies have when offering shares to the general public. The restrictions are far less onerous when those shares are sold privately to 'experienced' investors, such as business angels and venture capitalists.

The US has a relatively simple test for what needs securities regulation. The Howey Test asks whether a financial transaction will result in the buyer purchasing shares with the expectation they they will yield a profit from a 'common enterprise', where the profits will be generated purely by the company in which they are investing. By pre-purchasing, crowdfunders are not expecting to receive profits, but products. If a company offers shares without being regulated, there is a strong chance not just of directors being fined, but also disqualified from any future sales of company securities.

Because of the legal restrictions, crowdfunding sites that specialise in equity investment have sprung up. One example is UK-based Seedrs, which won FSA approval earlier in the year. The company believes there is a pent-up desire among many people to invest relatively small amounts in startup companies, many of which need only around £100,000 to get off the ground.

Seedrs is careful to stress that it is a site for investors who understand the risks involved. A key issue with early-stage start-ups is dilution of ownership as later-stage investors step in. Anyone who signs up to browse the list of start-ups has to sign a declaration that they have read and understood those risks. Once signed up, potential investors can browse through targets and put as little as £10 into a company. However, Seedrs says it will not buy the shares unless the startup raises all the funding that it seeks. The crowdfunder holds onto the shares and will distribute profits once the startup has been sold or it performs an IPO.

Because customers and investors need information before they put money into a venture, a potential pitfall of crowdfunding is loss of intellectual property (IP) protection. By publishing ideas on a public website, a company looking for funds for a product also risks having them copied by a competitor.

When start ups seek funding from business angels or venture capitalists, they tend to operate in 'stealth mode'; any sensitive information may be covered by one-to-one non-disclosure agreements and, even where those agreements are not used, there is lower risk of a competitor springing up because fewer people overall have seen the idea.

In practice, the risk of IP seeping away is not that critical. The detail provided through a crowdfunding site can be extremely limited. People paying $99 for early access to a physical product will generally demand less upfront data than a venture capitalist expected to put tens of thousands or millions of dollars into a company with no physical product in sight. The amount of disclosure needed for crowdsourced shareholders could be much greater, however.

Beware of giving too much away
For critical pieces of IP, a company seeking crowdfunding can apply for patents before publishing details of its work. In many jurisdictions, as long as details are not published before the patent application is made, the protection period – assuming it later turns out to be a valid patent – kicks in after filing.

Copyright applies to software from the point of publication, but one difficulty can be with proving who has the prior claim. One possibility is to use the Creative Barcode system, in which designers can time-stamp and mark files before they are uploaded to a server or distributed to prospective investors. Recipients of the files have to sign a form in which they declare they understand the terms under which the files are made available to them.

Even the concept of crowdfunding has become the centre of an IP dispute. Kickstarter has sought to invalidate a patent on crowdfunding obtained by Fan Funded after the patent holder asked Kickstarter to license its IP. While Fan Funded said that it has not begun legal action, Kickstarter argued that it felt under threat of being sued for patent infringement and wanted either to have the patent overturned or for a court to find that the site would not be liable for infringement.

Kickstarter has even become embroiled in an IP lawsuit against one of its clients. FormLabs. 3D Systems argues that FormLabs has infringed its patents on 3D printers, but has gone further by including Kickstarter in the suit because of its role in raising money for FormLabs.

One final issue with crowdfunding is that the intermediaries may not just withhold some money for their overheads – which is to be expected; some ventures may turn out to be nothing more than a pyramid scheme if the owners run off with the cash. Some sites claim to hold money in escrow to avoid this problem. Tougher regulation may help enforce this, but even the supposedly tightly controlled world of investment still suffers from these issues.

Despite the risks involved in a much more public way of raising funds, crowdfunding has clear attractions – not least because it opens up opportunities to a much wider range of investors and projects than the traditional mechanisms. Although a business plan would certainly help at the product prepayment end of the spectrum, there is no requirement to show one before receiving the money.

It also provides a way of testing the market – if no-one wants to prepay for a product, do you have the right product idea after all?

Author
Chris Edwards

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