Tuesday, March 27, 2012

Lesson #111: Crowdfunding Startups



Last week, the Senate passed the Crowdfund Act by a vote of 73-26, the sister act to the Jobs Act (or Entrepreneurs Access to Capital Act) passed by the House back in November by a vote of 407-17.  The two acts still need to be reconciled and enacted into law, but it is clear that both Democrats and Republications are in agreement on at least one thing: startups need easier access to capital, to help create jobs and stimulate the economy.  And, a solution is nearly here.  That is very good news to the entrepreneurial community.

As a quick history lesson, prior to crowdfunding being enacted, SEC laws limit private company investments to accredited investors with over $1MM in net worth or $200K of annual income.  That limited startup investing to largely the wealthy.  The logic of the law was that most startups fail, and the SEC assumed wealthier people made smarter investments and could more easily digest losses, and the masses wouldn't flush their life savings down the toilet on a bad idea.  But, the counter argument was "how is startup investing different than making donations or gambling", which is accessible to everyone.  So, with proper controls and the convenience of web enabled tools, crowdfunding could become a great resource to stimulate the economy.

The two acts are not in agreement on the exact details yet.  The House's act allows up to $10K investments or up to 10% of your income, to be invested into startups.  The Senate act, allows up to 5% of your income if under $100K per year (e.g., $2K), and up to 10% of your income if over $100K per year.  Another difference is the Senate requires the investment be made via an accredited crowdfunding marketplace, that is government screened, in an effort to control fraud.  Both laws require a verification process that the investors meet the stated investor thresholds.  It will be interesting to see what details finally get agreed upon in the final law, once enacted.

Price Waterhouse Coopers estimated that seed stage investments for startups totaled $920MM in 2011.  And, as evidenced by crowdfunding pioneer, Kickstarter, generating $100MM of funds pledged in 2011 by themselves, and the scores of additional crowdfunding platforms beginning to take off, access to seed stage investment capital will explode in the coming years, helping to launch the next generation of great startup businesses.

That said, entrepreneurs should be cautious about these new channels for capital.  Coordinating and communicating with hundreds of investors, can become much more cumbersome than dealing with one or two large angel investors or VC firms.  And, these "mom and pop" investors typically do not come with the networking benefits or strategic advice provided by professional investors.  At the end of the day, it is simply money.  And, some entrepreneurs need much more than money to make their businesses a success (e.g., Rolodex of connections, mentorship from people that have done it before).  So, buyer beware!

Most crowdfunding sources take a cut of the monies raised (e.g., Kickstarter keeps 5%, and their payment processor Amazon.com keeps 3%-5%).  So, make sure you read the fine print, and make sure you are asking for enough funds, once you net out these fees.  And, be sure to research the various nuances of these funds.  Things like: (i) where are they based; (ii) how many investors do they have in their network; (iii) how many successful fundings to date; (iv) what is the average size of their fundings to date; (v) the industry/product focus of these networks (e.g., music, design, CPG, green, startups); and (vi) whether they raise funds via "donations" that do not need to be repaid, or whether they are actually taking equity in your business.

As best as I have been able to research the crowdfunding market to date, I feel they fall into three camps.  First, you have micro-donations websites for various projects, like Kickstarter, IndieGoGo, Fundly, Microgiving, Helpers Unite, Pozzible (based in Australia) and Give A Little (based in NZ).  Most of these have a creative design project focus, cut could be accessed for good startup ideas.  Second, you have U.S. based micro-investment websites specifically focused on startup companies, like WeFunder, FundRazr, Microventures, Bank to the Future, Crowdfunding Bank, Early Shares, PathfinderBCM, RocketHub and Crowdfunding Offerings.  These are probably the best place to start for U.S. based startups.  Third, you have foreign based micro-investment websites specifically focused on startup companies, like Seedrs (UK), Crowdcube (UK), Crowdfunder (UK), CoFundos (Germany), Grow VC (Hong Kong), and Symbid (Netherlands).  They may do equally well, but not sure how foreign investor demand will be for U.S. based startups?  As a subset of these startup focused crowdfunding resources, there are ones specifically focused on certain industries, like Quirky for consumer products and Green Unite for ecofriendly projects.  And, I am sure there a many more in the works, that I haven't stumbled upon yet.  Time will only tell which ones of these will grow into dominant market leaders, given the infancy of this space.  So, do your homework on which one is best for your needs, location and industry.

For future reading on the matter, be sure to check out the crowdfunding section of Crowdsourcing.org, the leading research group in this space.  Or, check out this blog on crowdsourcing trends, called Daily Crowdsource.  

Here are some other useful articles I used to research this topic:

Senate Passes Crowdfunding Bill (from Techcrunch)
Senate Approves Crowdfunding (from Forbes)
Comparison of Crowdfunding Websites (from Inc.)
9 Crowdfunding Websites to Help You (from Web Distortion)
Crowdfunding is Great, But is it Right for Startups (from BostInno)

And, be sure to read my follow-up blog post from October 2012 with an update on key crowdfunding details that were beginning to emerge as of such date.

If any of you have had any good or bad experiences from working with the various crowdsourcing websites, or if there are others we should add to the list, please tell us in the comments field.

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