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There has been significant hype over the past year about the entrepreneur’s new fling,crowdfunding. In a sense, it takes the personal aspect out of the fundraising process by allowing many investors to get a piece of the action, but at a shallower level than angel investors. On the flip-side, it creates a presence that can make the already roller-coaster ride of creating a startup an even more epic underdog story or a magnificent crash and burn for the world to see. The playing field for crowdfunding is still in its infancy and it will likely be a few years before the dust settles. I would also like to make a distinction between for-profit crowdfunding and not-for-profit crowdfunding. Although a supporter of following one’s dreams and having other people pay for it along the way, the focus of this article will be on the former, because at the end of the day if you can’t make your business profitable you can hardly call it a business. Call it what it really is, a charity.

Various research reports have been commissioned with the purpose of exploring the phenomena known as crowdfunding. Although they offer subtle differences the nature of their answers are the same. Crowdfunding is a means to acquire financial stability, develop relationships (with investors or the consuming public), and to complete the feedback loop to achieve a form of quality assurance. Compared to the more traditional methods of capital-raising, crowdfunding offers a unique blend of the old and new. Although every capital raise is not held equal, they all try to maximize the ratio of capital raised to equity sold. That is of course from the entrepreneur’s point of view. Although the numbers for capital raised have not been incredibly large on a single project basis, they have been steadily increasing as the process becomes more familiar and popular. This is an area where VC shops will have control over for the foreseeable future. There is always a price to pay for the large influxes of capital offered by VC shops. It is not always the case, but the horror stories tend to be remembered more often than the successes, which usually involve a set of very sharp teeth that are lying in wait for the first drop of blood to be spilt.

A counter-argument to this negative light is that the hands on approach of many VC firms can add a much needed competitive advantage in the form of management expertise, relationship building, and an air of legitimacy. Take a glance at the table below for a high level overview of what the different methods of capital raising offer.

 

Crowdfunding 1

Table Source: See Reference Below.

 

Another distinction to be made for crowdfunding platforms deals with the participation rights of the investors. There have been four commonly identified ways of participation. Giancarlo Giudici sums up the four methods in his research paper titled Crowdfunding: The New Frontier for Financing Entrepreneurship? His summary is below.

 

Crowdfunding 2

Source: See Reference Below.

 

Whether or not crowdfunding contains the potential to make the capital raising universe more efficient is still up in the air. It certainly has enabled numerous small time investors the opportunity to invest in projects that otherwise would have been unavailable. It works both ways as well, in that many entrepreneurs have received funding that may have been passed over in the past. A key note to make is that the nature of the current crowdfunding universe involves a more emotional return than it does a substantial financial return. This partially equates to the low financial contribution, which is small enough to be considered negligible if there is any subsequent loss.

Crowdfunding is only gaining more momentum and it will continue to grow in the years to come. Whether or not it will compete with the established likes of venture capitalist firms is another question entirely. For a more in-depth look at the new frontier of crowdfunding check out the following report, the afore-mentioned Crowdfunding: The New Frontier for Financing Entrepreneurship?

 

 

References

Giudici, Giancarlo and Nava, Ricardo and Rossi Lamastra, Cristina and Verecondo, Chiara, Crowdfunding: The New Frontier for Financing Entrepreneurship? (October 5, 2012). Available at SSRN:http://ssrn.com/abstract=2157429 or http://dx.doi.org/10.2139/ssrn.2157429

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