Internet-based 'crowdfunding' draws the interest of startups

With the rise of sites like Kickstarter, so-called "crowdfunding" has emerged in recent years as a new kind of fundraising model, one that hinges not on the support of just a few investors with big coffers, but small commitments from many

Thomas Young's foray into earbud manufacturing came when he discovered a tangled heap of busted headphones in his son's room. Tired of constantly replacing the spent earbuds, the audio engineer and Durham resident decided to do something a bit radical: make his own.

Young believed he had found a hole in the marketplace. Nearly all earbuds, he thought, fell into one of two categories: cheap, plastic throwaways that deliver low sound quality and need frequent replacement; or those that have premium sound quality, but come with a premium price tag and still break with active use.

And so Young set to work designing earbuds that addressed these shortfalls. They would have three key aspects: audiophile sound quality worthy of an audio engineer, a reasonable price point, and — most importantly — modularity, so they could be repaired, not replaced, if a part were to break.

After all, if he had extreme earbud fatigue, he figured others must as well. So he decided to put it to the test.

But instead of pursuing typical investment vehicles to start the slow, capital-intensive slug of bringing his product to market, Young instead turned to the Internet.

At the beginning of June, Young submitted the project — which he dubbed Ironbuds — to Kickstarter.com, one of the largest funding platforms for entrepreneurs and artists on the Internet.

Young found a manufacturing partner, wrote a pitch, and set rewards for different funding levels. His project was approved.

Just three weeks later, Ironbuds surpassed its $11,380 fundraising goal, backed by more than 220 people from around the globe and with two months left to continue raising funds.

Rules change?

While Young talks to his manufacturer in China daily over Skype, hammering out details of the plugs and cords that will become the Ironbuds hardware, the pledges keep rolling in.

"Kickstarter is kind of a fascinating thing," said Young. "This crowdsourcing, it allows you to essentially test the market by getting people to pledge money."

With the rise of sites like Kickstarter, so-called "crowdfunding" has emerged in recent years as a new kind of fundraising model, one that hinges not on the support of just a few investors with big coffers, but small commitments from many.

Basically, said Young, "You have 1,000 mini-angels helping you out."

But unlike angel investors, those pledging funds don't receive a stake in the company for their investment, as existing law forbids granting equity without going through the costly process of registering with the Securities and Exchange Commission.

Instead, those who pledge money receive rewards. That might mean a book or CD when it's released, tickets to the screening of a documentary, or a home-cooked meal for those who just so happen to live in the San Francisco Bay area.

In the case of Ironbuds, a $21 donation lands the backer a standard earbud kit, but $33 gets them a deluxe kit and $47 gets them an Audophile Intellibud kit (complete with gold-plated plugs).

But while rewards are nice, some groups think equity offerings would be nicer.

In July 2010, the nonprofit Sustainable Economies Law Center filed a petition with the SEC, requesting that it consider an exemption to the law established in 1933 that bars small businesses from making a limited securities offering to unaccredited investors.

"These small investments can be a powerful source of grassroots and local funding for developing small businesses," reads the petition, which recommended that securities offerings up to $100,000 be exempt, with a $100 cap on individual investment, mitigating individual risk over a large pool of investors.

"The small amount at stake and maximum aggregate cap ensure the protection of investors while furthering the public interest in this type of investment," it reads.

The petition was posted to the SEC website, and comments on it have been overwhelmingly in favor of its passing.

The SEC seems to be listening. In an April letter to Rep. Darrell Issa, R-Calif., SEC Chair Mary Schapiro wrote that the commission was considering easing securities regulations to allow startups to raise capital through crowdfunding, noting that interest in the platform as a fund-raising opportunity "is growing."

If passed, this could be a game-changer for startups, whose biggest hurdle has always been access to capital.

For Young, there's enormous potential in that there is no barrier to entry — that anyone with a good idea can bring it to fruition.

"This is something that entrepreneurs should keep a good eye on," he said.

Investment and feedback

Crowdfunding has its roots in the artistic community, emerging as a place for artists, musicians, photographers and writers to fund their creative projects and reach out to friends, family and strangers for financial support.

"We knew personally about 30 percent of our backers," said Cozette Russell, a filmmaker from Lee who successfully used Kickstarter to raise more than $6,000 from 81 backers for her documentary, Brookford Almanac, which follows the daily lives of first-generation farmers on Brookford Farm in Rollinsford.

"Some of our highest donations are from people we've never met," she said. "It was really humbling."

The money she raised has allowed her to continue filming into her second year as the farmers struggle with losing their lease. Because Kickstarter is premised on all-or-nothing funding — meaning if the goal is not met, no funds are received — she said she purposely played it safe, setting the fundraising goal at a reasonable $5,000.

"One of the positive things is we've already created a network of people that know about (the film)," said Russell, who offered as part of the $500 pledge level the chance to name a calf. Two people backed it.

But while it emerged as an artistic platform, more entrepreneurs are taking note of the idea, with several sites — like Peerbackers.com and ProFounder.com — devoted solely to startups.

For Young, one of the biggest benefits of crowdfunding is being able to test the market, get feedback and adapt the product before committing even a dollar to it.

"You can basically touch a lot of people on the Internet at the same time, and you can get feedback from people quickly," said Young, whose backers hail from as far away as Australia, Sweden, Germany and Singapore. "If you hit (your goal), you literally are in business. If not, you can sit back and think 'At least I didn't waste that time.'"

Some of the Kickstarter success stories are astounding. The highest-grossing project ever was the TikTok+LunaTik watch kit, which converts iPod Nanos into a wristwatch. With an initial goal of $15,000, the project banked nearly $1 million in its Kickstarter run.

"After he did that, there must have been eight or 10 people who came up with watches on Kickstarter," said Young. "They garnered almost nothing compared to a million, because that guy was the first with an ultra-hot idea."

The watch kits are now sold through the LunaTik website, a move that Young also hopes to do once his project closes.

He's hoping to leverage his Kickstarter run into its own business, developing other projects for the Ironbuds line. After all, he can't help but notice how frequently his son's video game headsets break.

"I'd like to get my hands on some of that market," he said. "It's not going to change the world, but it'll be a nice business."