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The challenges crowdfunding plays in future of financing innovation

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Today, entrepreneurs have more funding options than before. In addition to traditional venture capital, Angel groups or individual investors, and corporate venture arms, there are proliferating crowdfounding platforms. To many, crownfunding may be a breakthrough in financing innovations, presenting opportunities for seed and early stage startups. Crowdfunding has raised $2.7 billion in 2012 globally, across more than 1 million individual campaigns. The trend continued to grow in 2013, where estimates rest at over $5 billion (according to a Crowdfunding Industry Report by Massolution). Currently, there are over 1,000 crowdfunding platforms, each offering different models and target various types of projects, where the most popular are Kickstarter, Indiegogo, RocketHub, Crowndfunder, and FundRazr.

How did the JOBS (Jumpstart Our Business Startups) Act change the landscape and what are the implications?

A the LES Silicon Valley meeting last week, experts discussed Crowdfunding, the JOBS Act, and the future of innovation funding. Recently, the JOBS Act has retracted the ban on solicitation, however crowdfunding platforms are waiting for the SEC to finalize its US-wide equity crowdfunding regulations.

There are several types of crowdfunding (CF) models, which are usually available through a web-platform:

  • Reward-based liked Kickstart, which has no limits. Here, funders donate via a collaborative goal based process in return for products, perks or rewards.
  • Equity-based, which under current CF law has many limitations
  • Equity-based under the JOBS Act

In equity-based models, entrepreneurs seeking invesments sell ownership stakes as equity or debt. Individuals who fund become owners or shareholders and have a potential for financial return.

So what are the hidden challenges with CF that many entrepreneurs and startups are unaware of and may stumble on?

The problem is that CF platforms do not exercise any vetting process and they will post any information the entrepreneur provides. Further, there is no validation of questionable campaigns or even criminal background check, which creates vulnerability for all participants.

Entrepreneurs need to be cautious of posting their business plans or details about their innovations online, since they may harm the prospects of patenting their ideas or products. Many are unaware of their IP (Intellectual Property) assets or miss protecting these all-together. There are also audit considerations that come to play, especially when funds raised are over $500,000.

The Jobs Act provided rules that entrepreneurs need to understand before seeking CF. Mary Juetten, Founder & CEO of Traklight, talked about the recommended steps startups should take on CF systems:

  • Identify IP
  • Protect IP
  • Pick a CF platform
  • Build social capital
  • Create a pitch

The first two steps are to identify and protect your IP. For example, issue a design patent or dim your potential copyrights before you put out your product online or on CF platform.

Juetten talked about the danger of getting blinded by posting information online in order to attract funds. When creating a pitch to set up a campaign, be careful on posting your business plan, your startup projections, or any videos that may disclose too much information. Another example is to avoid using music in your video-pitch without permission or that may violate others' copyrights.

What affects IP valuations today? What the implications that CF campaigns have on startup valuations?

Startups valuations assess the total addressable markets for the product, service or innovation. IP Valuations of early stage startups used to be private. However, trends have changed and now startup valuations become more public, which have huge implications on competition, taxing (exposure to the IRS, for example). Efrat Kasznik, President of Foresight Valuation and an expert in IP valuations, strategy, and economic studies, talked about the factors that impact valuations today.

On CF platforms, rewards-based campaigns versus equity-based campaigns present a different handling. In equity based, early stage valuation will be revealed, since the entrepreneur must put all the information out (on the CF online platform). For example, disclosing information such as the team, fulfillment, early customers, profits, and the production process. Further, disclosing financial statements online publicly also reveals the strength and viability of the emerging business. Exposure to potential investors is one thing; disclosing valuable information to competitors is another. On a reward-based campaign, you can limit on how much information you put out.

In addition to IP valuations, Foresight provides a number of services of patent valuations, trademarks valuations, and more. Kasznik talked about the difference between IP and patent registration: IP is part of the company’s assets while patents are issued outside the company and have a value outside the business or the associated its innovations.

Today, valuations include the following key indicators as measurable success factors:

  • User Engagement - how many active users
  • # of Installations (some users may install on several digital devices. For example, an app can be installed on a computer, tablet and smartphone by a single user)
  • Customer Acquisition Cost (CAC)
  • Customer Lifetime Value (LTV)
  • Average Revenue Per User (ARPU)
  • Customer Attrition and retention (Churn Rate)
  • Conversion Rate (sale funnel) - converting users into paid users

While private companies are growing fast, many delay their IPOs. However, opportunities for smaller-scale funding are available through Peer-to-peer lending. The crowdfunding industry is here and, in addition to individuals and angel groups, some leading financial firms are already embracing it.

ADDITIONAL INFORMATION

1. Traklight - www.traklight.com - Traklight is a tool that helps entrepreneurs and small businesses go through a safer and automated process before actually choosing a CF platform and setting a campaign. It also offers the legal community IP identification, storage, protection and management.

2. Foresight Valuations - www. foresightvaluation.com - Foresight offers a full suite of services to all businesses in many industries. The company works with clients to develop an active and informed approach to managing their intangible assets, from valuing IP portfolio, planning growth and for commercialization. Services include valuation analysis, economic studies (ROI and metrics), business strategy and monitization of IP, financial modeling for emerging businesses, as well as litigation support services. For details, check the website.

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