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Click to Invest: is crowd funding the future of raising capital in the creative industries?

​An Awfully Big (Double Fine) Adventure

Despite being an industry legend with much-loved games Full Throttle and Day of the Tentacle under his belt, Tim Schafer knew the problems he faced in pitching his latest point-and-click adventure idea to publishers.  At a time when current console games sales charts are dominated by blockbuster first person shooters and annual iterations of sports game franchises, it would be difficult to convince a publisher to take a risk on a slow-paced genre that had its heyday in the early 1990s.

“They’re just looking at the numbers,” Schafer, now helming Double Fine Productions, told Gamesbeat.  “They’re just looking at how much those games have typically sold and how much they could make if they did something like a shooter, and I think the numbers just don’t make sense for them.”[1]
You can see what he means by looking at the sales figures for a game like Modern Warfare 3, the latest in the Call of Duty series.  Worldwide, in various formats, it is estimated to have sold more than 27 million copies[2].  By contrast, Grim Fandango, another Schafer-designed award winning adventure game, was critically acclaimed on launch but is considered a commercial failure, selling less than 100,000.
So for his next project, provisionally called Double Fine Adventure, Schafer turned to US crowd funding website Kickstarter[3].  Crowd funding - enabling many individuals to contribute (generally fairly small) amounts to fund a project in return for the possibility of some future reward - isn’t a new idea, but the internet has made the process extremely easy and has made the pool of potential contributors much deeper.  
Originally seeking $400,000, Double Fine Adventure was fully funded in less than 8 and a half hours, raised over $1m in the first day and went on to generate $3,336,371 after just over a month. 
“I don’t want to say this is the end of the game industry as we know it…it’s not; it’s not!” said Schafer[4].  But it does serve as an excellent example of alternate funding methods for creative businesses, particularly those who produce niche content. 
In a previous KL Bytes[5], I looked at how the online games industry has proven that some projects can be really successful if they deviate from a uniform pricing model across all users.  Some users want to pay very little; some users actively want to pay a lot (for access to exclusive content or a product that few developers are making which will meet their interests) and  Kickstarter is the ideal opportunity for developers to engage with a big-spending audience.
Schafer agrees: “I think it’s a great way for a lot of projects, games or not games, to be made whenever the ‘gatekeepers’ - the big companies that decide what gets made and what doesn’t get made - are not serving certain segments of the fan base.  And enough of those fans can use the internet to coordinate and kind of pool their resources.  They can make it happen for themselves instead of waiting for these gatekeepers to do it.”[6] 
In other words: the risk of backing a niche product is minimised - instead of making a game and hoping fans buy it, the fan base is there before you start.
Schafer’s not the only one to see the potential of crowd funding for niche projects - inXile entertainment recently raised $2,993,252 to create Wasteland 2, the sequel to the Interplay Productions game which was the godfather to the hugely successful Fallout series.  Tiny studio Stoic, based in Austin, Texas, managed to obtain 723% of their original funding goal for The Banner Saga a turn-based tactical strategy game set in a hand-drawn Viking world described as a cross between Dragon’s Lair and Game of Thrones.
The Contributions Model

Kickstarter, and other crowd funding platforms available in the UK such as indiegogo[7], Crowdfunder[8], Wefund[9] and Peoplefund.it[10] all work in the same way, enabling business to seek donations or sponsorship and provide either no return or some form of merchandise or participation in the product development process in return for the financial contribution.
This model falls outside of the UK’s regulatory regime on investments, as the fans donating funds don’t get to hold shares in the company or participate in the profits generated by the project to which they are making their contribution.
Unfortunately, the examples listed above are very much the exception.  As not everyone has the status or has generated as much goodwill as Tim Schafer, most projects generate very low levels of donations.  Without a popular brand or a large network of enthusiastic fans, many developers find it almost impossible to raise money for projects in this way, without being able to offer a financial return for their supporters’ “investment”.  
Other Models

A useful alternative to bank lending, crowd funding platforms such as the UK Funding Circle[11] enable investors to provide funds by way of a loan which must be repaid in future with interest.  This type of model is less useful to creative businesses due to their general credit risk status and the fact that their projects tend to be high-risk / high-reward, meaning that there is a significant chance of insolvency if the project isn’t commercially successful (due to the loan carrying a fixed obligation to repay at a future date).
The better option for most creative projects would be to raise funds by allowing contributors to take a small shareholding in the business or to have profit-share rights, giving them the opportunity to participate in the success of the project (or to share the burden of failure without forcing the company to repay its donors).  Examples of platforms providing this type of crowd funding are CrowdCube[12] and Seedrs[13].  However, this model is highly regulated in the UK.       
Barriers to Crowd Funding: The Legal and Regulatory Framework

The Financial Services and Markets Act 2000 (FSMA 2000) restricts anyone from communicating an invitation or inducement to engage in investment activity in the course of business (called a “financial promotion”) unless he or she has been authorised by the Financial Services Authority (FSA), or the communication itself has been authorised by the FSA, or it is covered by an exemption contained in the legislation.  The terms used in this restriction are drafted so widely that, essentially, the regime applies to any communication made by a business in connection with it raising funding where the contributor is offered an opportunity to take shares in the business or obtain a return on their investment based on the success of the project.
Companies looking for traditional institutional capital can usually rely on one of the exemptions to get around the general restriction.  For example, where the communication is made to investment professionals, certified high net worth individuals or companies, or certified sophisticated investors.  The average crowd funding gamer, looking to help finance an exciting gaming project, is unlikely to fulfil any of these criteria.
Failure to comply with the regime leads to serious consequences.  Not only would any agreement entered into by the investor be unenforceable against him or her, but the person making the communication would have committed a criminal offence, punishable by way of a fine or a prison term for up to two years.  Even if the communication is authorised by the FSA, similar sanctions would also apply if the communication was found to be misleading.  
Where the donors are not given shares but are allowed to participate in the profits of a project, additional restrictions will apply, the extent of which will depend on whether the platform (which will be deemed to be a collective investment scheme or CIS) is regulated or unregulated, as determined by FSMA 2000.  It is likely that a crowd funding platform will be caught by the Markets in Financial Instruments Directive (MiFID), meaning that the operator of the platform will need to be authorised by the FSA and take account not only of the regulations made under FSMA 2000, but also the financial promotion rules in chapter 4 of the FSA’s New Conduct of Business rules.        
The Future of Crowd Funding

In the US, where the Securities and Exchange Commission (SEC) enforces similar restrictions, recent legislation has been adopted reducing the regulatory burden on entrepreneurs wanting to use the crowd funding model to sell equity.  The Jumpstart Our Business Startups Act (or JOBS Act) was signed into law on 5 April 2012 and permits small businesses to pool capital through crowd funding by selling up to $1 million in shares a year.  Investors would be able to realise any gain made on their investment by selling the shares after a forced year-long holding period, or if the company eventually floats. 
The details of the new regime are still to be written by the SEC, but the legislation looks to extend the grace period in which new public companies have to comply with Sarbanes-Okley governance requirements.  It also looks to cap the amount that individuals can invest:  participants with an annual income or net worth of less than $100,000 will be allowed to invest the greater of $2,000 or 5% of their income or net worth whereas those with more than $100,000 can invest 10% of their income or net worth, up to $100,000.
“The last few years have been pretty tough on entrepreneurs,” said President Barack Obama at the signing of the law.  “Because of this bill, startups and small businesses will now have access to a big, new pool of potential investors - namely the American people.”[14]   
Trade bodies like the Association for United Kingdom Interactive Entertainment (UKIE) are pushing for a similar reform of the UK regulatory framework.  In a recent report[15], UKIE called for the implementation of a regime that operates outside FSMA 2000, where financial promotions are standardised and many of the current restrictions are relaxed, creating what UKIE calls a “light touch” regulatory regime.  UKIE also favours the US approach of setting a maximum limit on the amount that one individual can invest, or enabling higher investments from specific individuals who are vetted as being adequately knowledgeable to understand the risks of investing in a crowd funding scheme.
The rationale for such change is clear: “Access to finance is a key barrier to growing the interactive entertainment industry in the UK,” UKIE’s report states.  “[We] consider that giving studios the ability to offer individuals the ultimate prospect of a financial return on their investment could open up crowd funding to a substantial number of businesses and therefore to give real impetus to the application of crowd funding in the interactive entertainment industries in the UK.”[16]      
Certainly, the rise of crowd funding has highlighted the weaknesses inherent in the current UK regime.  Although platforms like Kickstarter are extremely easy to use, transparent and regulation-free, they rarely enable businesses to raise more than small amounts of cash.  UK start-up businesses are unable to use the crowd funding model to offer a financial return in exchange for an injection of capital (which would increase interest in investment) without coming up against large regulatory hurdles.
Indeed, even understanding the current financial promotion regime, let alone navigating through it, would force most small enterprises into incurring legal fees, diverting much-needed cash away from actually growing the business.  As game industry commentator Nicholas Lovell of Gamesbrief witnessed: “At my GDC financing panel, I asked if anyone had raised [over] $10K with Kickstarter.  One man put his hand up: Tim Schafer’s lawyer.”[17]    


For more information, please contact Andy Moseby 


[1] www.venturebeat.com/2012/02/21/double-fines-tim-schafer-on-kickstarter-success
[2] figures from www.vgchartz.com
[3] www.kickstarter.com
[4] www.joystiq.com/2012/03/13/double-fine-adventure-kickstarter-concludes-with-$3,335,265-amassed
[5] Feeding the Whales: How Videogame Business Models Have Changed, and What this Means for M&A; www.kemplittle.com/Publications/item.aspx?List=77D08281-399F-4C65-8BCE-6E39B9E941E4&ID=14
[6] www.venturebeat.com/2012/02/21/double-fines-tim-schafer-on-kickstarter-success
[7] www.indiegogo.com
[8] www.crowdfunder.co.uk
[9] www.wefund.com
[10] www.peoplefund.it
[11] www.fundingcircle.com
[12] www.crowdcube.com
[13] www.seedrs.com
[14] www.bloomberg.com/news/2012-04-20/investor-caveats-raised-as-startup-funding-rules-loosened
[15] UKIE Crowd Funding Report: A Proposal to Facilitate Crowd Funding in the UK (February 2012)
[16] Ibid., page 2, page 8.
[17] www.gamesbrief.com; as quoted in Edge Magazine May 2012