November 02, 2012
Crowdfunding: A Conflict for VCs or a Path to Economic Recovery?
I attended an event on crowdfunding recently. Entrepreneurs are dabbling in anything and everything "crowd" lately - from attracting vendor and engineering talent to volunteers and now, funding. I've had friends test out Kickstarter which is an interesting model if you don't need a lot of cash to jumpstart your project.
It's easier to get low-level investors on board since the commitment on the part of the 'investor' is minimal (mostly zero) and there's a reward kick back. I've contributed as little as $5-50 to a Kickstarter project and did it because it was a cool idea and just wanted to help. You'd need a helluva lot of "me's" to make it worthwhile at that level but there are others who will invest $100, $1K or $10K into the pool depending in their interest and wallet size.
Other reward based crowdfunding platforms include IndieGoGo and RocketHub, all of which are operating in the new paradigm without a lot of rules and regulations, aka pre the implementation of the 506c Act.
In a conversation on crowdfunding and alternative funding for start-ups, below are two videos (Part I and Part II) that discuss the pros and cons. Note that it IS a VERY Silicon Valley viewpoint and I haven't met a whole lotta venture capitalists from major firms who want to deal with the aftermath of early investors no longer being one or two angels but being 25 random no-names instead. There are complications AND implications.
On the panel included Gerd Goete, Siemens Venture Capital, Partner, Don Ross, HealthTech Capital, Managing Director and Founder, Sand Hill Angels, Board Director and Life Science Angels, Member Carol Sands, The Angels' Forum, Managing Member, Graham Burnette, SBV Capital Partners and Red Planet Capital, General Partner and Royse Law's Roger Royse.
I didn't get the sense that VCs (or at least traditional VCs) would be in full support of coming in after crowdfunders, largely because of what's involved: complicated, too many heads at the table, dillution and more. Silicon Valley focused, their mantra was more around the traditional tools that make a startup successful in the long term: domain expertise, access to the right people, advice and coaching and the amount of due diligence that goes into a deal.
There's no question that access to the right people and being 'aligned' with the right people accelerate deal flow and increase the likelihood of a successful exit. If you're Kleiner backed, your chances of success go up regardless of what kind of "useless" app you have.
There are the notorious three risks, which include:
1. Technology Risk - do you have a kick-ass technology? (my words, not theirs?). Can it do what it says it will do? Will it live up to the promise?
2. Market Risk - is there a big enough market for your products?
3. Expansion Risk - this comes into play as you start to scale. Can you make a big enough return that is attractive for YOU and for them? (aka, your investors)
Their argument was that dozens or possibly hundreds of 'crowdsourced' investors can't help with 1, 2 or 3. That said, my argument would be that there are a ton of businesses who don't need to go through the traditional Silicon Valley funding route and while crowdfunding may not give them millions, they still may be able to find advisors for a point or two who can leapfrog them into the right 'tribe' so they can be successful without giving away the store to a traditional VC firm.
It is indeed an alternative and some business models and businesses will work and some won't.
Points for considration include: public solicitations and use of social media, advertising terms of offer being restricted to the fact that the issuer can only direct investors to a broker/funding portal, the additional costs invovled with disclosure and reporting, use of an intermediary, risk of fraud (goes up as this model expands), and the point that the VCs and angels on the panel referenced again and again: the high number of unsophisticated investors (which leads to fiduciary duties to all investors and as our Silicon Valley finance pals pointed out, all of "it" a concern for VCs for future fundraising rounds).
We learned a bit more about new guidelines under the proposed 506 regulations.
For example, it would allow for public advertising and general solicitation in Rule 506 offerings, provided that the issuer takes reasonable steps to verify that potential investors are accredited, and all investors are accredited (or the issuer reasonably believes they are) at the time of the sale of securities.
This results in all sorts of issues we haven't faced before under traditional models, including the nature and terms of the offering which are unique. Is it a low verus high investment? What are the terms? Who has a voice and doesn't? And of course bearing in mind that there will be more steps needed to verify 'accredited' status.
Proposed crowdfunding regulations are slated to be released in January 2013. Videos below in Part I and 2 of the panel (roughly 20 minutes for each video - feel free to view the whole thing or catch snippets in stages to get an overview).
The event was part of iHollywood Forum, and their new brand Angel Launch, which produces dinners, venture forums, and seminars for entertainment, Web, Internet, mobile and tech ventures and startups.
Also refer to a Forbes article on crowdfunding where they also talk about the above legislation and a bill that had full bipartisan support this year called JOBS (Jumpstart Our Business Startups) Act, which is a series of 6 bills tied together designed to make it easier for startups to gain access to capital.
Photo credit: Forbes.
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