Funding any business venture can be daunting, especially for entrepreneurs, who must sometimes raise millions of dollars from private investors to launch a new idea. Eric Migicovsky, CEO of Pebble Technology, found a way around this problem. When Migicovsky was unable to raise money from investors for his Pebble e-watch, a device able to connect to Android and iPhone smartphones using Bluetooth technology, he took the idea to the crowdfunding Website Kickstarter. By the time his company had closed its campaign, 70,000 people had contributed a whopping US$10.2 million to see his smartwatch realized. Migicovsky is not the only one to enjoy wild success by turning to the masses for money. At the time of this writing, the makers of the Star Citizen video game surpassed Pebble Technology by raising more than US$2.1 million in funding on Kickstarter and more than US$15 million on its own site using the WordPress crowdfunding plug-in called IgnitionDeck. The game is planned for release in December 2014.
Crowdfunding Web sites, such as Kickstarter, Indiegogo, and RocketHub, have changed the way entrepreneurs think about raising money. No longer are new business ventures reliant solely on a few well-heeled angel investors or professional venture capitalists (VCs). Instead, they are increasingly turning directly to the public to elicit hundreds or even thousands of small donations. As of April 2012, according to the 2012 “Crowdfunding Industry Report,” published by the industry group Crowdsourcing.org, there were more than 450 crowdfunding Web sites across the globe. In 2011, companies raised US$1.5 billion in funding on these sites with US$837 million raised in North America alone.
This mode of funding has been particularly effective in the world of arts and media, where crowdfunding has successfully funded movies (Veronica Mars), video games (Star Citizen), and music ventures (Universal Music’s The Vinyl Project). It seems to work especially well with ventures in which there are already eager fans anxious to see their favorite star return to the big screen or spend another few hours battling a new group of virtual enemies. But can this model work in the sciences? Can biotechnology start-ups turn to crowdfunding to finance new research, devices, treatments, and drugs?
Many scientists believe it can, especially in the age of government austerity and slim research and development budgets. Walter De Brouwer, a Belgian Internet and technology entrepreneur, successfully raised more than US$1.6 million on the Web site Indiegogo to fund his Scanadu Scout Tricorder, a handheld scanner outfitted with sensors that can read vital signs and send them wirelessly to a smartphone. De Brouwer says the model has changed from “build it and they will come” to “come with enough people and then we will build [it].”
Crowdfunding: A Brief History
In the arc of history, crowdfunding is nothing new. Crowdfunding, or the idea of individuals pooling funds to support the efforts of other people, has been used for centuries to help fund political campaigns, finance disaster relief, and help jump-start civic projects. In the 17th century, booksellers sold their books at discounted prices prior to printing, similar to the way many crowdfunded projects function today. But in the Internet age, raising money has taken on a newfound sheen: the pervasiveness of the Internet allows for potentially greater sums to be raised from a larger group of people spread around the world. By going online, businesses are able to ask for donations to a project (which are treated strictly as gifts), provide stock in exchange for money, or, like the 17th-century booksellers, promote a discount on a product or service when purchased in advance. The makers of the Pebble smartwatch, for instance, presold their device by allowing contributors to preorder a watch for a contribution of US$200.
The last decade has seen a number of large crowdfunding platforms become an established avenue for entrepreneurs to get funding. ArtistShare, which was started in 2003, was the first but was in time joined by Indiegogo (2007), Kickstarter (2009), RocketHub (2010), and others. As these platforms have grown in number, they have also become more specialized, and today there are many dedicated entirely to science and technology. These include WiSEED, a French biotech crowdfunding platform that has helped fund anticancer drugs for several biotech start-ups, Microryza, which focuses on funding academic research, and the recently founded Health Tech Hatch, Poliwogg, and Medstartr.
Sam Wertheimer, managing director of Poliwogg, notes that crowdfunding can be especially useful in the health care sector. “The model can work for any industry,” he says. “We just think health care is an area where there are well-defined communities of interested potential investors… and it is an area of tremendous innovation and value.”
Crowdfunding Comes to Biotech
Biotech may be particularly ripe for crowdfunding as healthcare becomes a growing concern due to the world’s aging population. Alex Fair, CEO of the crowdfunding platform Medstartr, argues that crowdfunding not only allows companies to find funds in ways that would have been impossible in previous years, but has empowered consumers as well. It begins, he says, “with patients saying ‘I want this’ and then their doctors start to listen.” In turn, he says, that creates better products and services and better and more effective healthcare.
Since Medstartr’s inception in 2012, the platform, which is focused on the development of medical projects and devices, has financed 30 projects, including a software program called CyberDoctor, which allows patients to track and develop a treatment plan online in collaboration with their physician. According to Fair, the platform has helped 62% of its projects reach their funding goals—more than six times the industry average for health care projects—and has raised a total of US$9 million over its short life span, with an average of US$200,000 raised per project. About 5% of the funds raised for each project come directly through the site. The other 95% are raised from large companies that either approach Medstartr or are approached by Medstartr. For this service, Medstartr charges a commission of 5%.
The France-based platform WiSEED has helped several biotech enterprises raise money since 2009. These include Urodelia, a biotech start-up developing innovative drugs against cancer (fund-raising closed/€800,000 raised), Antabio, a biotech start-up developing innovative drugs to treat antibiotic-resistant bacterial infections (fund-raising closed/€300,000 raised), Ambiotis, a firm working on new drugs and treatments against inflammation (fund-raising closed/€100,000 raised), and Selexel, a biotech start-up developing anticancer drugs (currently raising funds/seeking €100,000). According to cofounder Thierry Merquiol, WiSEED has helped 27 companies raise €5.5 million in equity funding.
Microryza, founded in 2012, has funded more than 40 projects, raising on average US$10,000 per project. Unlike most of its competitors, Microryza currently focuses on funding academic research as opposed to early-stage companies. Microryza cofounder Denny Luan explains that while all levels of researchers have sought funding, “most projects involve early investigators—graduate students, postdocs, and assistant professors.”
Health Tech Hatch focuses primarily on health-related technology and, according to CEO Patricia Salber has funded 25–30 projects since its inception in 2012. In addition to helping projects find funding, the platform is also dedicated to assisting entrepreneurs with shaping their ideas. The projects funded are relatively small, in the range of US$5–10,000, but the organization has partnered with Indiegogo (by posting a link on the Indiegogo Web site) and has been able to raise their financing average to US$100–150,000 per project. For now, those interested in funding projects on Health Tech Hatch are merely donating their money or receiving a discount on a product or service. In the future, this may change to receiving equity in a company.
Poliwogg plans to focus on funding small and midsize companies in biopharma and other health care specialties by 2014. CEO and founder Greg Simon has said that their Web site, established in 2012, works differently than others in that it will not be geared toward raising money from individuals but will seek out investors willing to hold equity stakes in companies looking to raise between US$2 million and US$10 million. The Poliwogg model is based on crowdfunding only a portion of what a company seeks and then persuading venture capitalists to fund the remainder after conducting a due-diligence review. If an organization raises the funds it seeks, Poliwogg collects a 5% fee from the proceeds.
Poliwogg intends to help companies move through the initial critical stages of development when it can be difficult to get a venture capitalist interested. In an interview with Genetic Engineering and Biotechnology News, Simon explained it this way: “We fund these companies; they get across the ‘valley of death’ one way or another. They either fail, which is highly possible, or they succeed. They get a proof of concept. They get a critical clinical trial done. All of a sudden, they’re interesting to a biopharma company or a VC. Think of this as a feeder for biopharma and VC funds. Neither VCs nor companies get into that level. But if you don’t grow companies at that level, you’re not going to get the companies at the bigger level. That’s why we’re called Poliwogg: You’re not going to get a frog if you don’t invest in the poliwogg.”
What is it?
On 5 April 2012, President Obama signed into law the JOBS Act. The Act is intended to encourage investment in American small businesses by easing securities regulations. It allows companies to accept contributions from private individuals (a practice otherwise known as crowdfunding) without having to make an initial public offering.
What does it do?
There are many provisions to this bill, but the most significant for small start-ups looking to crowdfund are these: A company may now raise up to US$1 million per year from individual investors. This money can be donated, or a company may choose to offer a good, service, or equity shares. Investors with a net worth or annual income of less than US$100,000 (or nonaccredited investors) can invest a maximum of US$2,000 a year or 5% of their annual income (whichever is greater) in a business. Those with a net worth or annual income greater than US$100,000 can invest up to 10% of their net worth or annual income, whichever is greater. Previously, to invest in a company, an individual had to be an “accredited investor,” which meant earning more than US$200,000 a year, US$300,000 with a spouse, or have US$1 million in assets. A company may have up to 2,000 shareholders, with up to 500 nonaccredited investors before it must register with the SEC. For the first time, companies are allowed to advertise that they are looking for funds and can sell themselves to investors through a broker or Website registered with the SEC.
Why is this helpful to start-ups?
The door is now open for both accredited and small, nonaccredited investors to invest in a fledgling idea or company. One of the key provisions of the law is that start-ups will be able to directly advertise to investors and publicly market themselves. This is a tremendous new advantage for companies who were previously only able to attract funding on a one-to-one basis, through appeals to friends or family, or by going through a broker.
When will the JOBS Act be implemented?
Parts of the JOBS Act are already up and running. For instance, small companies obtaining less than US$500,000 from investors can already file less detailed financial information before a public offering. But other portions of the Act, as of the writing of this article, have yet to get started. For instance, the law allows for companies on equity crowdfunding platforms to promote their investment offerings outside a verified accredited investor community online or through social networking sites (such as Facebook, Twitter, and LinkedIn) as long as that promotion leads back to a platform that verifies accredited investors before giving them access to the investment offering. But that provision of the law has not yet taken effect. Industry insiders believe that most of the crowdfunding provisions of the law will not take effect until 2014.
Are there limitations to the JOBS ACT?
A few call it a step forward but not yet transformative because it would not touch the entirely new potential capital market of nonaccredited investors or help formalize and grow the friends-and-family funding market.
It may also have a downside. Whenever a company seeks to bring in new investors, it must seek approval from every investor already owning equity in the company; in a crowdfunded company, that could be a lot of people. If the company seeks to bring in more investors, existing investors may have little incentive to approve an expansion since their equity shares will lose value.
Some biotech companies are also concerned about what they call the lack of interagency communication. While the SEC may have attempted to make life easier for crowdfunders, the Food and Drug Administration (FDA) still demands the same level of testing from both small crowdfunded companies and large institutions. Smaller companies would like to see more assistance in place to facilitate FDA approval.
Critics say that new SEC filing rules may actually result in more paperwork for small businesses rather than less. For example, the Act mandates reviews of financial statements for offerings of between US$100,000 and US$500,000, and audits of financial statements for offerings of more than US$500,000 (noting that the maximum
offering of US$1,000,000). This can mean less paperwork for the company below the US$500,000 mark and more if you are above it. Small companies often find it difficult to find the time, money, and personnel to develop a new product while also keeping up with paperwork. In addition, being held accountable to hundreds of new investors also requires more personnel to deal with those investors and conduct public relations and financial planning.
Finally, some observers fear the new law may be a disservice to unsophisticated investors who may be more likely to engage in crowdfunding and who are more easily hurt when a small company does not make it.
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Check out this Infographic on the JOBS Act.
As crowdfunding gains steam as a fund-raising vehicle, the U.S. federal government is also looking for ways to encourage this form of investment. The Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama in 2012, allows start-ups to advertise, market, and publicly disclose the fact that they are fund-raising on crowdfunding Web sites in exchange for equity (see “The JOBS Act and Crowdfunding Explained”). Thanks to the JOBS Act, companies seeking to crowdfund should find it easier to do so because they will be able to accept funds from an unlimited number of “unaccredited” investors (those earning less than US$200,000 a year with less than US$1 million in assets) and they will be able to publicly appeal to “accredited” investors, or those earning more than US$200,000 a year with at least US$1 million in assets. While it remains to be seen how the JOBS Act will shape the crowdfunding landscape in the coming years, crowdfunding platforms are already adapting. Poliwogg, for instance, intends to market to both accredited and nonaccredited equity investors.
The Risks of Crowdfunding
Clearly, crowdfunding has achieved some success in cases in which the public can obtain an immediate benefit from a product or device. If there were an extremely effective new device available for baldness, wrinkles, or obesity, crowdfunding might be the way to go. But can crowdfunding work in contexts where a new device or treatment may be many years down the road? Can it work in a typical biomedical venture that might require several million dollars of investment before a new drug or treatment is developed? Can it work for devices and treatments that have a much smaller market? Are researchers in the highly competitive world of science willing to unveil an early-stage project in the public sphere? And will the JOBS Act of 2012 undermine crowdfunding by increasing the burden of administrative paperwork and accounting oversight for startup companies with limited resources and time? These questions remain to be answered.
The Scanadu Scout, the device built by Walter De Brouwer, is a great example of fast, effective crowdfunding for a device with mass appeal. Investment in his product was quickly oversubscribed, providing the working capital and initial customer base to justify production on a larger scale. But when it comes to the discovery of new therapeutic drugs, Xconomy writer Luke Timmerman sees crowdfunding as playing a relatively limited role that needs to be augmented with other funding sources. “I think you are going to see companies raise US$500,000 or even a million dollars and that we will see them bundle that money with foundation money, or National Institutes of Health grants, or private angel investors,” says Timmerman. He argues that start-ups may be able to raise only limited amounts of money this way, while simultaneously losing control of their companies, since crowdfunding equity investors have the power to decide whether to expand equity to new investors. Essentially, they can decide how fast a company can grow. Timmerman sees this as problematic. De Brouwer and others, however, see it as a more democratic way to run a company. Another issue is that crowdfunding may lack the ability to get the essential, less appealing research done. The crowd may rush to fund a project with an immediate payoff, such as a cure for baldness, but may be less interested in funding research that is less consumer friendly.
From the investor’s point of view, Timmerman says, crowdfunding opens up other concerns. He doubts whether small investors most likely to engage in crowdfunding are sufficiently knowledgeable in biotechnology to really know whether a project is viable or not. “There is a real potential problem with investors getting fleeced with these early-stage companies because they aren’t going to be held to the same standards of disclosure that publicly traded companies are with their Securities and Exchange Commission (SEC) filing and their rules and regulations. I think there is a lot of potential for these small operations to overhype, overstate some of the evidence they have gathered, in the hopes of raising more funds. In short, a lot of people could lose a lot of money.” Because of the newness of crowdfunding in science-based ventures, there are many open questions that may be answered once the SEC rules are fully in place, but there is also the possibility that they will not.
Despite these potential snags, crowdfunders and industry analysts agree that there is a market for crowdfunding of health care ventures offering novel products and services. People want to put their money toward solving problems about which they are passionate and in places they think their investment will be most effective. Timmerman offers an example. If an investor wants to see a new Parkinson’s drug created, he or she cannot be certain that donating to the Michael J. Fox Foundation or investing in Pfizer will see that happen, he says. But with crowdfunding, an investor might specifically contribute to a project investigating a new Parkinson’s drug. “Crowdfunding allows people to invest in exactly what they want,” he adds.
Want to Learn More? Visit These Sites
For Medical, Health, and Biotechnology Crowdfunding
General Crowdfunding Websites