Depending on who you talk to crowdfunding has a different meaning from micro-finance, to good causes, marketing to equity investments. What does this mean for investors? This is dependent on the type of crowdfunding; from donations (no returns) to reward based (such as tickets to an event, acknowledgement on an album cover, or a computer game) through to interest payments and a repayment of capital over time and shares or debentures based.
Crowdfunding is the practice of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the Internet. The proliferation of online platforms such as GoFundMe over the last decade gives the impression that this is a new digital phenomenon. It’s not. It’s just easier. In 1997 British rock band Marillion asked US fans to pay in advance for the next album so they could tour the US – they did.
Most of us associate crowdfunding with philanthropy but its origins were commercial; so it should be no surprise that your business may well be using it, thinking about it or dependent on it.
Business crowdfunding took off after the financial crisis and the challenges SMEs and entrepreneurs found in obtaining loans. Kickstarter one of the largest platforms, celebrated its eighth birthday in 2018 during which time almost 15m backers invested over £3.7bn supporting more than 400,000 projects. Many of these small businesses would have traditionally sought out bank loans yet with a compelling story or the offer of beta products an alternative funding source is available that doesn’t have to be paid back. What does this mean for financial services? How can interest-bearing loans and credit-rating hurdles compete on such an uneven playing field?
Large corporates also use crowdfunding as a marketing tool to create demand for change and test the market; engaging and gaining support from potential customers for product launches in areas such as wearable technology, computer games, software, food and drink. Indiegogo Enterprise specialises in supporting campaigns for big brands like GE, Hasbro and Motorola.
Internal auditors may wish to think about their supply chains and partners. Small, niche organisations may be funded in this way, particularly creatives, tech innovators and artisans. What sustainability risks does this present? How financially stable are they? How critical are they to your organisations success? Could vertical integration or partnership be an option? If they have grown very quickly are their operations robust and compliant?
Also, is your organisation engaging in this? What are the reputation risks? Are accounting processes robust? Is there an effective risk management process for beta products to limit liabilities? Could pressure from GDPR restrictions be tempting marketeers away from traditional email campaigns?
There is also investment/debt crowdfunding. At a basic level this is micro-financing. Platforms create the opportunity for high-risk investors to finance loans as part of a collective, green energy and housing are popular sectors. Investors can choose from platforms that invest in businesses (peer-to business) or to individuals (peer-to-peer lending). Taking this one step further is equity crowdfunding, also known as crowd-investing or crowd-equity. Platforms (eg Seedrs, CrowdCube) facilitate people to invest in an early-stage unlisted company in exchange for shares in the company.
Crowdfunding in its many guises has become an established part of the system, facilitated in part by the disruptive technology of blockchain. It is a fast-paced industry with cryptocurrencies also beginning to feature on some platforms in the form of ICOs (initial coin offerings). The financial world is in flux with barriers to entry being eroded by digital technologies. It is not just internal auditors in the financial services sector though that needs to be rethinking long established controls and test plans; it is internal auditors in all sectors that operate crowdfunding opportunities.
Some types of crowdfunding need to be authorised by the Financial Conduct Authority (FCA). Loan and investment based crowdfunding are regulated activities under the Financial Services and Markets Act 2000. However, donation and pre-payment or rewards-based crowdfunding are also regulated. Any internal audits in this area need to consider compliance with the FCA regulations.