Crowd Funding: A Viable Funding Option For Buying Businesses?

It’s been a year since President Obama launched the Jumpstart Our Businesses Startups Act (the Jobs Act), which sought to ease federal regulations inhibiting small business lending, as …

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It’s been a year since President Obama launched the Jumpstart Our Businesses Startups Act (the Jobs Act), which sought to ease federal regulations inhibiting small business lending, as well as individuals from becoming investors.

With crowd funding no longer restricted to accredited investors, the growth of platforms like Kickstarter, Indiegogo and Fundable has accelerated.

But if legislative changes have sparked an increase in crowd funding activity, might it also herald a widening of the scope of its application?

Despite signs that credit constraints are finally beginning to ease – small business lending rose for the first time in 10 quarters at the end of 2012 – there’s clearly an appetite for exploring unconventional alternatives, even if this particular alternative is marketed at start-ups and early-stage investment.

Generating small sums of cash from large numbers of investors, crowd funding is an inversion of traditional forms of finance like business-angel investment where one or two high net-worth individuals contribute tens or hundreds of thousands or even millions of dollars.

What equity-based crowd funding and angel investors have in common, however, is a preference for innovative, early-stage companies with strong prospects for growth.

Because while angel investors invariably inject cash in return for a sizeable chunk of equity, peer-to-peer lending can also be undertaken in the form of a loan.

While crowd funding (the first web-based example of which occurred when fans of British prog rockers Marillion underwrote the band’s entire 1997 US tour) has now captured the imagination of Silicon Valley, it’s yet to resonate with the wider entrepreneurial fraternity, if the latest BusinessesForSale.com survey is anything to go by. Asked whether they were even aware of the concept, 61% of prospective business buyers admitted that no, they had not.

Business brokers, the intermediaries who oversee the business-sales process, were more au fait with the information-age funding medium, with more than half (55%) conscious of its existence.

And only 17% of would-be business buyers said they had contemplated using crowd funding – also known as peer-to-peer lending – rather than equity-funded, to raise finance, although this figure rises to 44% when taken as a proportion of respondents who knew what crowd funding actually was. Consider that business-orientated platforms such as Fundable or Crowd Cube are primarily aimed at start-ups and expanding businesses and the level of interest from aspiring business buyers is intriguing.

Twelve percent of buyers polled said they’d actually used crowd funding in the past or expected to use it in the future.

Quizzed about its potential application to business sales, 37% of business brokers said they thought crowd funding could be a useful tool in raising acquisition finance, while a similar proportion (39%) agreed that it was underused as a funding option. Meanwhile, 43% believed economic conditions were combining with legislative changes to create a perfect stimulus to its growth, with buyers desperate for alternatives amid an on-going credit shortage and savers exasperated with poor returns on their savings accounts.

That still left a significant proportion with misgivings about crowd funding, however. Asked to comment further, one broker said crowd funding was generally only suited “to smaller transactions, and those which can easily be described and the business model fully understood via an internet offering.”

Another intermediary voiced concerns that the “concept could easily attract a lot of con artists”. A valid misgiving, no doubt, and new approaches always take time to earn trust (just remember shoppers’ reticence to submit credit card details in the early days of internet shopping).

And, indeed, there’s no such thing as risk-free investment. With crowd funding, however, you can at least invest across multiple businesses, thereby spreading your risk.

Apprehension about this unconventional funding model was evident among buyers too, one buyer dismissing it as “a fad with no use”. Another (apparently, without irony) said: “I consider funding from reputable sources like banks and not individuals.”

In a financial marketplace where credit remains scarce, there’s clearly a strong appetite for exploring novel methods liked crowd funding, if accompanied by apprehension and even puzzlement among the older generation.

Crowd funding is set to be a growing feature of business funding, acquisition finance included, even as skittish traditional lenders show signs of finally recovering their nerve.

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