July 12, 2012 9:51 pm

Start-ups eye crowd-funding for capital

In the start-up culture in US creative industries, fledging businesses often look to a few key, angel investors for their first funding. Now some start-ups are tapping thousands of individuals online for money – though the cash for these “crowd-funded” projects comes mainly in the form of advanced purchases or out-right donations, rather than traditional investments.

A deal this week has highlighted how crowd-funding has become a growing source of capital, particularly in areas such as video-game development.

Ouya, a Los Angeles start-up that sought $950,000 to produce a $99 games console, this week made a record-breaking debut on Kickstarter - a website that has led the way in raising funding from the grassroots donations of web users.

Ouya raised $1m just eight hours into its 30-day appeal and, by Thursday, it had passed $4m from more than 30,000 individual backers.

“The Kickstarter platform is exceeding our expectations, it enabled us not only to raise money to bring Ouya to market, but to engage in a direct dialogue with future customers,” said company founder Julia Urhman.

New York-based Kickstarter launched three years ago and has raised some $250m for some 25,000 projects including books, films, webcomics, video games and a high-tech watch. A rising number of rivals include Indiegogo and RocketHub.

Kickstarter’s rules forbid equity offers. Instead the start-ups offer alternative rewards ranging from T-shirts to actual products, depending on the size of the contribution. Ouya’s include $10 pledges to reserve a username for their gaming platform, $100 for the promise of a console and $5,000 to spend a day with its designer, Yves Behar.

Ouya’s launch was timed to coincide with the lifting of a media embargo on its console, ensuring news stories would help drive interest.

“In just 24 hours, 20,000 people bought an Ouya console – a product they had never heard of before yesterday. By way of comparison, Microsoft sold 326,000 Xbox 360 consoles in its first week after many millions of marketing dollars,” Kickstarter said on its company blog.

Some experts say crowdfunding will expand into equity raising after this was given regulatory backing in the US with the passing of the Jumpstart Our Business Startups – or Jobs – act in April. This act eased some of regulations surrounding equity raising.

“With the Jobs act, you are going to see tremendous growth and acceleration in the number of platforms available for small-business owners looking to raise capital,” says Scott Steinberg, author of The Crowdfunding Bible.

Mitch Lasky, general partner at the Benchmark Capital VC firm, said that it was only a matter of time before crowdfunding site users begun to demand equity in the companies.

“If one of these companies turns out to be [games developer] Zynga and worth $4bn, I’m not sure I’m going to be happy with just a T-shirt,” he said.

However. some critics say grey areas in the Jobs Act for this new financing method could leave consumers open to fraud.

Jay Ritter, a finance professor at the University of Florida, added that Kickstarter had become an unlikely success since people who make donations on the site have no way of knowing if their personal contributions will make projects successful.

He predicted this would not be followed by a boom in using “crowdfunding” by businesses to raise equity from individual investors.

“For something to take off, investors chase past returns, and I don’t think there will be many successess,” he said.

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