Crowdfunding Law

Let's Get Crowdfunding Right

Month: December, 2011

Crowdfunded Companies Can Benefit From Guidance

In my initial post I took issue with an opinion piece that suggested that crowdfunding is a bad idea because it will not provide early stage companies with the strategic insights and networking help offered by alternative investment sources such as VCs and angel.  Crowdsourcing.org was kind enough to reprint that post here.  Given the questions and feedback received so far, I thought I would clarify a few positions:

Crowdfunded Companies Can Benefit From Experienced Guidance:  Clearly, any new business can greatly benefit from seasoned business experience and sector specialization.  What I was responding to was the suggestion that VCs and angels routinely provide this guidance and that this guidance plays a material role in the ultimate success of the company.  I don’t believe this is the case.  Further, I do not know any VCs or angel groups that believe this is the case. I also have a confidence that crowdfunded companies will be able to leverage experience and expertise without any investment from traditional sources.   An expanded “crowd” ownership model only increases the likelihood that help will be available from actual investors.  Beyond investors, great resources such as Startup America will put your startup in touch with proven experts.  Register for startup help.  Its free (VC and Angel help is far from free).

Some Crowdfunded Companies Will Fail for Lack of Experience:  Yes, some crowdfunded companies will not succeed and part of that failure rate will be due to inexperienced founders.  Against a VC “success” rate that anticipates 80% failures, I am willing to give the wisdom of a broad-based crowd a shot at predicting better success.  I doubt it will be worse.  There is plenty of risk in early stage investments.  People in the crowd need to be aware of that and the maximum investments should be limited (and will under every proposal).  However, this is, again, not worse than what is expected in VC and angel backed companies.

VCs and Angels Have a Role in Early Stage Finance: Clearly, VCs and angel investors provide much-needed capital for early stage businesses and will continue to do so.  However, numerous studies show that VCs are investing in early stage companies with less frequency after the economic crash.  Angel investors tend to be very slow and unpredictable and often expect unreasonable rights and valuations.  In this financing atmosphere, crowdfunding stands to play a huge roll.  Crowdfunding will not be right for every early stage business.  If you are in a high capital business like many renewable energy companies, crowdfunding probably makes little sense because crowdfunding rounds will be capped at relatively a small number (likely $1 million – $2 million) and subsequent investors are unlikely to want to deal with a large existing shareholder base.  This type of business will still need a limited number of investors and will only make sense in a VC or angel financing round.  VCs and angels will remain quite necessary–but crowdfunding stands to fill a big void in the right sectors.

 

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Crowdfunding Can Be Very Good for Business

As the concept of lawfully using crowdfunding in the United States for equity investments in startup companies continues to build support on Capitol Hill, Carol Tice opines in Entrepreneur that this mechanism for permitting a multitude of small investments by a large group is “bad for business”. http://www.entrepreneur.com/blog/222429   As grounds for this belief, Tice asserts that investors who only make a small investment through the “crowd” will likely have neither the incentive nor the ability to provide the “high-quality expertise” that early stage companies “need to be successful.”  Because this argument substantially misses the value and huge opportunity that crowdfunding provides to entrepreneurs in favor of an idyllic version of VC and angel investment, I must respectfully disagree.

The starting point for her conclusion that crowdfunding would be “bad for business” is rooted in this assumption that angel investors and venture capital firms provide assistance to portfolio companies in a manner that materially impacts the success or failure of the venture.  I am afraid that this is a claim that even venture capital firms and angels investors would seldom seriously make.  The often ballyhooed claim by investment groups of a “value–add” (“our money is more valuable than their money because of the value we bring to your business”) is not even routinely realized by entrepreneurs.  Sometimes…but not often.  This is the case with even the highest pedigree of specialized VC firms http://www.avc.com/a_vc/2004/01/that_much_vaunt.html, let alone lesser firms, angels and angel groups.  Stretching a “value-add” claim to a prediction of overall success or failure of the entire venture is simply a claim I have never even heard.

Further, I know of no venture capital firm who would even make an investment in a startup management team if they perceived that success or failure would be materially impacted by the value and guidance the investors could bring.  Venture firms have a broad portfolio and tend to be very stretched operating their own companies, reviewing potential deals and monitoring portfolio investments.  Being responsible for the success of the venture is something they have neither the time nor the inclination to do.

Suggesting that crowdfunding is “bad for business” based on this idyllic concept of venture and angel investment totally overlooks the actual potential of this new capital raising tool.  The reality is that, in most cases, investors of all kinds only bring cash and, well, cash is simply cash, no matter the source.  If it is enacted into law in the United States, crowdfunding will enable the pooling of capital to provide new business funding in a way never realized before.  Further, the democracy of the crowd itself will help vet successful business plans and models and will level the playing field in order to provide capital on the most favorable terms to new entrepreneurs with good ideas.

At a time when banks are not lending for new businesses, venture firms are shying away from early stage investing and angel investors demand unreasonable rights and valuations, crowdfunding offers the chance to use the power of social media to enable new business funding and related job creation.  This is the power of social media and the internet.  It is the future.  This is not to say that there are not genuine concerns that should be addressed in this legislation in order to protect against real issues such as fraud and abuse.  That is being done in the proposed legislation.  However, suggesting that crowdfunding should be avoided based on a polyanish view of existing funding alternatives does little to advance the debate and realize the potential.

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