Crowdfunding: The Democratized Way to Financing Your Company
Singularity University conducted a poll about the greatest barriers to starting a business. The greatest barrier at the top of everyone’s list was raising money. According to the US Small Business Association, lack of capital is the main reason why 50 percent of new businesses fail within their first five years of operations.The solution to this disparity is crowdfunding. Technology’s most powerful ability is that it allows entrepreneurs to scale their solutions to impact a broader group of people. In this same manner, crowdfunding is an online platform that enables entrepreneurs to scale their networks to gain access to funding for their projects from like-minded individuals across the globe. It has been shown that 23 percent of companies are so daunted by the prospect of raising money that they don’t even try and 51 percent get turned down for their efforts. Through this online platform, entrepreneurs are able to reach millions of new customers and potential backers. Crowdfunding has democratized and decentralized the fundraising process for entrepreneurs. The power to fund an idea is no longer in the hands of the small percent (i.e. VCs) and concentrated in one area (i.e. Silicon Valley). Instead, entrepreneurs can receive funding from geographically anywhere and from anyone despite background because of crowdfunding.
The issue of fundraising hits even harder in the minority community where less than 2% of venture capital-funded startups have African American founders. Minority entrepreneurs success in raising venture capital has been limited by a few factors. One of those factors is that human capital is a crucial part of the investment decision. “Human capital” valuation factors in gender and race which leads to bias investment decisions. The power of financing companies has been given to a small few involved in venture capital and with 76% of VC partners being white men, according to National Venture Capital Association/Dow Jones VentureSource, they do not equally represent the startup world demographics.
Though minority entrepreneurs struggle to receive funding from venture capitalist, there has been a reverse effect when it comes to raising funds through crowdfunding platforms. According to the Regulation Crowdfunding, campaigns run by women-only founders had an 87.5% success rate compared to 41% for men-only founders. Minority-only founders also had a higher success rate of 46% than men-only founders.
Types of Crowdfunding:
- Incentive or Reward — In this model, the supporters give money to the project that they would love to fund. In return, the supporters receive a reward or incentive. If you donate money in this scenario you might receive merchandise and if you donate more you might receive a copy of the product you are funding, somewhat like a pre-sale. Examples are Indiegogo, Kickstarter, and RocketHub.
- Equity — This model is also known as crowd-investing, investment crowdfunding, or crowd equity. Equity Crowdfunding was created due to the passing of the 2012 Jumpstart Our Business Startups (JOBS) Act. This Act changed regulations to the US Securities and Exchange Commission which now allows entrepreneurs to sell equity in their company online in exchange for money. Examples are WeFunder, Crowdfunder, and if an entrepreneur has already raised their first 100,000 then they can utilize Angel List
- Debt — The debt model sometimes referred to as peer-to-peer (P2P) lending or micro-lending. This model of crowdfunding requires entrepreneurs to request a loan from the crowd. This loan will then have to be paid back with interest. Examples are Kiva and LendingClub.
- Digital Donations — Donors give money to a campaign they deeply care about. The most a donor will receive is a receipt to claim on their taxes and a letter of gratitude. Examples are DonorsChoose, GlobalGiving, and Causes.
Equity crowdfunding has raised $2.5 billion, donation crowdfunding has raised 5.5 billion, and peer-to-peer lending has raised $25 billion. Crowdfunding is on an exponential growth curve. In 2009, crowdfunding raised $1.5 billion dollars and is projected to reach over $100 billion dollars by the year 2020.
Five Characteristics of the Best Crowdfunding Campaigns according to Diamandis, author of Bold, are:
- Product aims to solve a problem, improve an existing product and/or tell a new story
- Product is community focused and consumer-facing
- Product is usually in late prototype phase, sufficient to show prospective backers what they are supporting
- Team has a large community of followers or has the ability to generate massive media resources to attract attention
- Team is correctly assembled and capable of executing
It is also important to note that campaigns that raise at least 30% of their target amount within the first week are more likely to succeed.
The period between “I have an idea” and “I am actually working on the idea” is where the initial fundraising process begins and the entrepreneur must keep as much momentum as possible. Money is a resource that enables entrepreneurs to move through the phase of vision to reality, but time is of the essence. More and more VC’s are noticing that there is a need to create different avenues for entrepreneurs to finance their projects. Indie.vc, being one of them, has a cash distribution model that allows entrepreneurs to focus on cash flow and sustainability vs. fundable milestones. Another VC firm challenging the traditional VC model is Social Capital. Social Capital is experimenting with a “capital-as-a-service” model which is based on the principle of data based decisions rather than intuition or affinity.
Though VCs are creating new models to provide different avenues to financing an entrepreneur’s business, crowdfunding is catapulting entrepreneurs from idea to reality phase expeditiously while knocking out two stones at once, financing your company and finding potential customers across the globe. Internationally, crowdfunding has added 65 billion dollars to the economy and started 270,000 jobs. Crowdfunding is democratizing the financing process by giving the crowd, the potential users, the power to dictate what deserves to be financed and support projects they care about that will, in turn, affect their communities in profound ways.
To learn more about crowdfunding here are a few further reads:
