Crowdfunding and Esports: A Unique Combination
As it relates to esports, crowdfunding is often used to describe prize pools for tournaments, as organizers have found that it can be a cost-efficient way to provide impressive dollar figures. The International, Valve’s premier annual Dota 2 event, raised some of the biggest prize pools in esports history with its most recent crowdfunding campaign that raised more than $38 million USD towards the tournament’s total, plus Valve’s contribution of an extra $1.6 million. However, only 25% of all in-game purchases made during the crowdfunding campaign go towards the prize pool. Valve keeps the remaining 75%.
As companies search for new ways to raise funds, other forms of crowdfunding have found their way into the esports ecosystem. Crowdfunding, which is roughly defined as a method to secure funding for businesses or projects from a broad, disaggregated mass of people, usually through an online platform, can be separated into different types, including reward-based crowdfunding — which includes most crowdfunded prize pools but is also used to launch new products and services such as the card game The Bazaar, which was financed through a $115,000 crowdfunding campaign on Indiegogo — peer-to-peer lending, which has not seen much use in the esports industry, and equity crowdfunding, through which everyday investors can acquire tiny equity stakes in esports companies.
The roots of crowdfunding
Equity crowdfunding is still a relatively new phenomenon. In the aftermath of the 2008 financial crisis, the U.S. government passed several bills aimed at economic revitalization, including the Jumpstart Our Business Startups Act (JOBS Act), which became effective in April 2012 and was signed by then-President Obama. The Act was passed in May 2016 to make it easier for “small money” to participate in capital-raising platforms, as it legalized the use of crowdfunding to issue securities and opened up funding participation to non-accredited investors in the U.S.
When it was originally implemented in 2015, the Securities and Exchange Commission’s (SEC) CROWDFUND Act rules imposed a number of restrictions on companies seeking funding through equity crowdfunding. Under Regulation Crowdfunding (Reg CF), non-accredited investors can now participate in funding rounds that were previously only open to accredited investors and venture capitalists. However, the bill limits how much people can invest through equity crowdfunding based on their income. In addition, Reg CF limits the amount of funding a company can raise through equity crowdfunding to $1.07 million in a 12-month period.
There has been a flurry of activity on platforms such as Kickstarter (founded in 2009), Indiegogo (founded in 2007), Crowdcube (founded in 2009), and several equity crowdfunding platforms since the proliferation of crowdfunding regulations in other countries. Due to more lenient regulations outside of the U.S., most equity crowdfunding campaigns for esports companies were launched by companies based outside of the U.S. Order Esports, an Australian esports organization, raised approximately $264,000 on Birchal, and Fnatic, a British esports organization, raised approximately $2.45 million on Crowdcube.
Regulations inhibiting crowdfunding
Meanwhile, equity crowdfunding activity in the U.S. remained insignificant following the introduction of the CROWDFUND Act, with one of the few examples being esports entertainment platform Juked.gg raising the allowed $1.07 million maximum in January 2021 under Reg CF. Reason for the low equity crowdfunding activity in the U.S. can be found in comparing the $1.07 million equity crowdfunding limit to the roughly $4 million average sizes of seed financing rounds in the fourth quarter of 2020 and $16 million average for Series A rounds in the same period according to Wing VC. Those numbers show, that a lot of business plans require larger sums than $1 million to get off the ground. While the U.S. introduced a Regulation A+ (Reg A+) parallel to Reg CF, which allowed startups to raise up to $50 million per year via equity crowdfunding, though introducing far more stringent documentation requirements.
Equity crowdfunding isn’t completely off the table for U.S. esports companies as Reg CF, Reg A, and Reg A+ are being updated at the end of 2020 and going into effect early 2021. Consequently, the Reg CF offering limit has been increased to $5 million and all limits for accredited investors have been removed, while Reg A+ offering limits have been increased to $75 million, potentially making equity crowdfunding a more attractive option for the U.S. esports companies.
Pros anThe pros and cons of crowdfunding in esports
Aside from the amount of money esports companies are potentially able to raise through equity crowdfunding campaigns, several additional aspects make it a viable alternative financing method. An esports venture will have the ability to focus on its business plan and communicate its ideas in channels native to the esports ecosystem such as video content, social media campaigns, and events, rather than in business meetings and written pitches. In addition, equity crowdfunding reduces the financial risk for entrepreneurs involved, tests the marketability of a project or brand, recruits hundreds of brand ambassadors, and creates access to funds that small businesses may not otherwise have.
Equity crowdfunding is not without challenges as well. The company’s extensive network supporting the campaign, for example, is crucial to the success of the campaign. As well, after a successful campaign, investors are likely to have follow-up questions, wanting to change their investment or back out altogether. Equity crowdfunding campaigns usually take a long time to complete and last for several months.
In terms of equity crowdfunding in esports, the biggest challenge is the inherent risk for investors. There has been a very limited number of successful equity crowdfunding campaigns by esports companies and projects in recent years. So far, no equity crowdfunding investors in esports have been paid a return on investment to demonstrate the viability of this investment. Equity crowdfunding is a very risky form of investment, especially for non-experienced investors, who are usually targeted by crowdfunding campaigns.
A 2020 study by Financial Innovation states that the probability of a company’s failure eight years after a successful equity crowdfunding campaign is about 63.4%, while less than 13% of companies can expect to exit, which is the only way for investors to make a return on their investments. In addition, equity crowdfunding investors usually have no (significant) vote in the company, lack a sophisticated due diligence process that could protect them from fraudulent campaigns, and often can’t liquidate their position at will unless the company is traded on a secondary market.