There has been a bit of action for a while now in the crowdfunding world, and certain startups have been able to get themselves off the ground using the Kickstarter / Indiegogo style sites. By and large, these types of financings have gone to companies that are building physical products, digital games, etc. Fundings have also happened for some causes, films, art projects that are typically not businesses. Equity crowdfunding isn’t legal yet in the US. But presumably, it will become so. In Europe, it is legal. Hopefully, other parts of the world will also start seeing the infrastructure develop.
For our audience, the primary concern is financing digital startups: technology and technology-enabled services. Typically, these are difficult to assess, high-risk companies, and amateur investors from the ‘crowd’ are unlikely to be able to perform adequate due diligence to have a sophisticated investment thesis.
However, there is one category of investors who will have an excellent vantage point from which to assess new ventures.
I am talking about customers.
As a case in point, I would like you to read the Modernizing Medicine case study on this blog. Daniel Cane, co-founder of Blackboard, is doing a new company in healthcare IT that he has ‘crowdfunded’ from customers. Technically, it is not crowdfunding as in the financing was not completed on Kickstarter or a similar site. However, Daniel raised the funding from a bunch of doctors who were enthusiastic about his product and wanted to invest. This converted customers to investors, massively enhancing their stake in the game, and incentivizing them to promote the product to large numbers of other doctors who are likely prospects for the company.
Equity crowdfunding, I believe, will vastly scale the opportunity for entrepreneurs to engage their customers as investors.
In fact, all sorts of strategic players who can make a company successful, can take a stake in it: potential channel partners, media, analysts, domain experts who want to play across a set of companies in their core expertise area, etc.
This is really exciting!
You may ask, where does that put VCs and professional angels?
Well, the ‘crowd’ is not good at leading rounds. Even so-called angels often don’t know how to lead rounds. I would argue, the number of investors who know how to lead a round is quite small.
However, to raise an equity round, you need a lead investor to set a valuation and issue a term sheet. Also, as I discussed in an earlier post, good VCs have leverage.
Savvy entrepreneurs will, most likely, work with savvy VCs and angels to set the terms and then invite their customers, partners, and strategic influencers to participate. Savvy VCs and angels will recognize the value of having these strategic players in the round, and will not object. After all, everyone makes more money if the company has more levers to push to accelerate growth.
In a sense, what we’re projecting here is a small scale private placement round that could include a few hundred investors, or may be, a few thousand.
This is not easy to manage. It is not viable for an entrepreneur team to go personally meet a few thousand geographically diverse investors and answer their questions personally. Most of the process will need to happen online. The role and credibility of the lead investors remain significant drivers in the financing game. Amateurs will look for the professionals to lead.
This will remain the primary bottleneck for the scaling of equity crowdfunding as a solution to the seed capital gap that startups face today.
At least for a while, the people who will take true advantage of equity crowdfunding are the ‘insiders’. In that sense, crowdfunding will, likely, not democratize startup financing to that extent.