Crowdfunding is a relatively new part of Startup ecosystems. A larger percentage of people that I know in the startup world, both investors and founders, support crowdfunding. They are going by the theory that more is better. Most also believe in freedom, equality, open access and other basic tenants of American society. The basic idea of crowdfunding fits with that.
I am not for or against crowdfunding. It’s a reality and I think that investors and founders need to grapple with what it means for their investments or company. If you want to understand the finer legal points surrounding crowdfunding, check out William Carleton’s blog. He does a great job defining and explaining.
When analyzing it, I think it’s critically important to use positive economic analysis, and not normative analysis to understand crowdfunding and its effects and outcomes on startup ecosystems. Using words like “good” or “bad” emotionally charge the issue, and lead you down the wrong intellectual thought/evaluation path.
Depending on who you are as a founder, crowdfunding can help or hurt your business. Experienced founders that have successfully navigated the hard entrepreneurial road before probably can benefit from taking some crowdfunded money-as long as it isn’t the lion’s share of their capital raise.
Experienced founders know what they are doing. They need less mentorship, and generally have a great network of previous contacts they can tap into to help them when problems occur. When they organize boards, they bring in the right people to help them.
But even experienced founders need mentorship, help attracting customers and general strategy help. It is unclear how they would tap into that from a group of crowdfunded investors. It’s also unclear how they would manage those investors in the capitalization table, and what later stage investors would make of crowdfunded groups on that cap table.
If you are an inexperienced founder, I wouldn’t recommend a crowdfunded deal. Maybe a small slice. But you will need the mentorship of investors and their networks to help you through the rough seas you are going to face.
There is a life cycle of investment for every company. Rarely is it one round and done. Corporate finance is a strategy just like marketing, operations, HR, or any other strategic decision a CEO makes.
From the investor perspective, crowdfunding is a double edged sword. The advantage is that the investor might get into more deals that they otherwise wouldn’t see. I live in Chicago, and the deal flow that I see generally comes from the midwest. If I wanted to break into the deal flow somewhere else, it would require investment of time and money to build a trusted network in those places. With online crowdfunding, I can do it virtually.
However, as an investor, I don’t like to spray and pray with my investment dollars. Crowdfunding is that approach. It’s hard to have a meaningful effect on the outcome of a company by investing in this manner. With the rate of failure in startups, my guess is there aren’t going to be a lot of big home run wins in Crowdfunded investments. Because of the value engaged early stage investors bring to the table, my guess is Crowdfunded companies will do worse than traditionally funded companies in sum. That’s a hypothesis and it’s far too early to tell.
As an investor, I also like to get to know the management team extremely well before I invest. Before I invested in Marc and Dan’s Kapow Events, I knew them for five months. We got to speak on several occasions. We were able to have breakfast and knock down a few beers with each other. Before the money went into the company, we had a good relationship. You can ask them what they think of my performance as an investor post investment-but they have done all that I have asked of them.
One thing you learn early on in angel investing, bet on jockeys not ideas. Crowdfunding strikes me as betting on ideas.
If you are an inexperienced startup investor, I wouldn’t use crowdfunding. You are guaranteed to lose money. You are better off donating to a favorite charity. If you really want to invest in startups, invest in a fund that specializes in this type of investing-or join a local angel group. You might lose the same amount of money but you will have better impact and the probability of success for you is probably higher.
There is wisdom in crowds. Markets make better decisions than individuals. But markets also are disciplined with constraints and experience. It’s not clear that crowdfunding replicates a market of rational investors.
As Crowdfunding matures, it’s going to evolve. It’s important to keep good data on outcomes. What we have today is only data on dollars invested. What I’d like to know is how crowdfunded investors have helped companies other than with a check. I’d also like to know success/failure of exclusively crowdfunded companies versus the metrics on traditionally funded ones. Good data will tell investors and founders a lot.
I have a general idea of how I think a well managed crowdfunded fund could work(and work powerfully well)-but haven’t put it into practice yet because the rules are still being written. Maybe an investment house or bank and I could develop a cool partnership.