Entrepreneurs Turn to Crowdfunding for Working Capital, Proof of Concept

February 15, 2012

Entrepreneurs looking for working capital may want to add a new fundraising option to the top of their list: crowdfunding.

In the last four years, a handful of crowdfunding sites have emerged in the United States and are growing rapidly. Several entrepreneurs and outdoor companies have used the sites to raise working capital for new products by essentially pre-selling those products to consumers.

Here is how it works: An entrepreneur posts a proposal outlining a new product, service or charity project they want to launch and then solicits backers to donate to their project in exchange for rewards. Rewards can include anything from logoed T-shirts and coffee mugs to limited editions or customized versions of the product.

The all or nothing model

Most crowdfunding sites work off an all-or-nothing model. If pledges reach the fundraising goal within a prescribed time period — usually 30 to 60 days — the sites collect payment from the backers, subtract a fee of four to five percent plus payment processing fees, and hand over the money to the entrepreneur. If the goal is not met, the offer simply expires and no money changes hands.

Crowdfunding sites began emerging four or five years ago and now include Kickstarter.com, Peerbackers.com, Indiegogo.com and Rockethub.com. Each tends to focus on different areas, and business models vary. Kickstarter.com and Peerbacker.com allow projects to remain open for up to 60 days, while Indiegogo.com will let a fundraiser continue for up to 120 days. Indiegogo.com clients can also elect a “flexible” plan that allows them to collect pledges immediately in exchange for an additional five percent fee on top of its normal four percent fee.

Crowdfunding has grown dramatically since the 2008 recession. As of last July, Kickstarter.com was raising as much cash in a month as it did in all of 2009. The company had collected $60 million of $72 million pledged for 10,388 projects at that time. Its project approval rate was running at about 44 percent.

The Backcountry Boiler
Among the projects funded was one designed by Devin Montgomery, 29, who developed Backcountry Boiler, an aluminum camping stove that uses twigs and other natural fuel. Montgomery pre-sold 200 units of a prototype of the stove to fellow camping enthusiasts he met on the community board at BackpackingLight.com. Based on feedback he got there, he refined his design and built a waiting list of customers. He then turned to Kickstarter.com to raise $20,200 he needed for tooling for an injection molded stopper and other features he wanted to add to the product. Two days after launching the Kickstarter.com campaign, he raised a third of the amount. At the end of the 30 days, he’d raised $60,642 from 563 backers.

Montgomery is still working to fulfill orders due to a dispute with a contractor, but said the Kickstarter.com campaign enabled him to pay for his tooling and other costs and put away money for his next production run.

“I’m working off the revenues from the Kickstarter funding round to make my next batch,” he said of the Backcountry Boiler. “I would definitely consider using it to sell a new product.”

Kammok, an established outdoor company, raised $208,853, or more than 10 times its fundraising goal in September from 1,909 backers on Kickstarter.com.

Great proof-of-concept tool
Antlerstudios recently used Kickstarter.com as a proof-of-concept tool for a new line of children’s boots. Founder Andrew Estey said he is funding the project internally and hoping to defray some of the costs of tooling, traveling to Asian factories and filing patents by pre-selling the boots on Kickstarter.com. He suspended his Kickstarter.com campaign after it failed to attract significant pledges within the first few days of going live. He suspects children’s products may not fare as well on crowdfunding sites, where the decision to pledge is often triggered by a deep personal interest in a hobby, technology, social cause or other personal interest. He is now reevaluating his campaign and may reactivate it next month.

“The benefit is that if you have successful campaign, you have story to tell in front of potential investors and buyers,” he said.

Whether crowdfunding can become a significant new source of working capital in the long term hinges on Congress, which is now considering the Entrepreneur Access to Capital Act (H.R. 2930). This bill would essentially allow companies to raise up to $2 million from stock sales through crowdfunding sites without having to register the underlying securities with state or federal regulators.

In the meantime, you may want to add crowdfunding to your fundraising, proof-of-concept, social media toolkit.