New Venture Lab: Equipping Christian Entrepreneurs

I'm Not Convinced That Crowd Funding Works for Startups

The concept of crowd funding and Christian crowd funding in particular seems to be a hot topic right now as several NVL members have asked me about it recently. So here goes…

I think crowd funding like Kickstarter works well for small projects where the “investors” get a CD, MP3, video or book in exchange for their “investment”. In reality, the Kickstarter relationship really makes the person “investing” their small amount of money more of a “customer” that is “prepaying” for the item they want rather than true risk capital. 

I'm not convinced that crowd funding will work well beyond small projects. A typical early-stage company that is burning cash and going through a "J" curve for years as they attempt to create a product, test market demand, scale the company to profitability, etc. carries a lot more risk than sending a musician five dollars in exchange for getting a song and a bumper sticker the following month. 

Also, there is a lot of value to venture capital beyond just the capital. Venture capital investors provide recruiting, mentoring, networking, strategic thought partnership, strategic alliances, board governance, accountability, a focus on getting to a high-return exit, etc. that crowd funding does not bring to the party. That’s why venture capital is called “smart capital”. Yes, the venture capital investors get their pound of flesh in exchange for the value added and every entrepreneur is wise to consider the full cost of the relationship, but it is a proven formula that has worked for decades. The venture capital sector has struggled in the past ten years to get the kind of returns it used to, but I do not think that the reason is connected to the difficulty of the raise or the 25% friction cost (annual management fees over a number of years and carried interest) the professional venture capital investors charge in the bargain. In fact most crowd funding sites charge 5% to 15% with the median around 9% or 10%, so there isn’t a huge cost advantage to crowd funding.  

So if crowd funding still carries the cost, but does not provide any value outside of “dumb capital”, what exactly does crowd capital bring to the party? Supposedly a much easier funding process where millions of potential investors will eagerly send you money with no strings attached. I’m sorry, but I’m not convinced. I might be wrong, but please check back with me in a few years and let’s see what really happened.

Oh by the way, be sure to Google “does crowd funding work” and you will find either glowing praise from the uninformed or horror stories about extremely high failure rates of crowd funding campaigns in the high 90% range. 

I’d love to hear from just one person that was able to raise more than $250k for a real startup, got the money, got the startup launched, exited the startup, and returned capital to the investors with a meaningful return in a reasonable timeframe. In fact, let’s set a really low bar and just show me where someone was able to raise $250k period. That would go a long ways to convince me. Until then, color me skeptical.

Read more about raising capital.

Mike Liles, Jr. August 30, 2012

Startup businesses currently using crowdfunding to raise funds through preordered goods or services, and the crowdfunding portals too for that matter, had better hope that the businesses can timely produce and deliver the preordered goods or services before the business’ pre-ordering customers complain to state authorities that they have been ripped off. What most entrepreneurs and crowdfunding portals do not realize is that under the securities laws of many states (which like the rest of the world have access to information posted on the internet) payments for pre-ordered goods or services that are used as risk capital in the start-up of a venture involve the sale of a “security” that must be registered under those laws. Enforcement actions by state securities regulators are typically triggered by customer complaints, and crowdfunding portals may well be caught up along with the business, not only for failure to register the security but also for failure to register as a broker-dealer. The resulting regulatory history could preclude either of them again engaging in crowdfunding under the JOBS Act for up to ten years in the future. Better to wait until the SEC promulgates definitive crowdfunding rules under the JOBS Act and then to comply meticulously. Please see Stevenson & O'Leary, "Definition of a Security: Risk Capital and Investment Contracts in Washington, 3 UPS Law. Rev. 83 (1979), a law review article on the risk capital criterion for, among other things, determining whether preordered goods or services involve the sale of a security.

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