Fail Fast or Win Big: The Start-Up Plan for Starting Now (2015)

CHAPTER SEVEN

Entrepreneurs Have a New Investor: The Crowd

The traditional ways of creating and launching an entrepreneurial company still exist, but the world of start-up funding has changed forever. Crowdfunding, which is the raising of capital primarily through an Internet platform in the form of donations or investments in exchange for future products, lending, or equity, has opened up opportunities never before possible. But let’s take a look at what was available and now what is possible.

TRADITIONAL SOURCES OF FUNDING

In the not too distant past, if you needed some money to start a business, you’d look to several sources. First, you might examine your savings or, perhaps a bit riskier, you could leverage your credit card. Or, you could turn to friends and family to raise the necessary funds.

Another traditional source of funds, if you had collateral, was local banks. Possible funding, based on your product, could come from angel investors, those early investors in a company. With some initial growth and revenue, it might be possible to attract private equity investors. Finally, based on the opportunity, industry, and size of the marketplace, you might receive funding from venture capitalists in exchange for an equity stake in your company.

However, funding was difficult to get outside of friends and family. Angel investors typically only do one to three deals per year and average in the $25,000 to $100,000 range. Through their formal and informal networks, angel investors might be exposed to 15 to 20 companies per month. That wasn’t great odds for an entrepreneur. With venture capitalists, the odds for an entrepreneur receiving funding went down further still. Industry averages show that venture capitalists invest in about one out of every 400 deals they review. While their funding levels are higher, $3 to $7 million per investment, they are extremely selective. Especially after the Internet bubble of 2000 and the recession of 2008, venture capitalist firms have been hesitant to look at start-ups that are not yet generating significant customer adoption or revenue.

“The way to get started is to quit talking and begin doing.”

—Walt Disney

THE NEW SOURCE FOR FUNDING

The entrepreneurial ecosystem of financial support has radically been altered. In 2009, a new form of funding arrived, called crowdfunding. Crowdfunding is when hundreds or thousands of independent people “crowd together” to fund a project that usually entails the launch of a new product by a start-up company. Initially, crowdfunding was project based, providing entrepreneurs with capital, usually in the form of “advance sales” of a product. Early crowdfunding platforms included IndieGogo and Kickstarter.

But now, based on legislation related to the JOBS Act of 2012, crowdfunding has been extended to include new equity platforms that can be used to raise capital in exchange for equity stakes in these companies. The Securities and Exchange Commission (SEC) will finalize the rules for equity crowdfunding sometime in late 2014.

To better understand crowdfunding and its potential impact, let me walk you through how we got here and exactly what it looks like, how it works, and how to maximize use of crowdfunding platforms. Then, we will look into the future and see what impact this new type of financing will have on the entrepreneurial ecosystem.

Why Crowdfunding?

The crowdfunding platforms arrived on the scene for several reasons, including technology, efficiency, opportunity, and available investors. Did we ever imagine just how powerful the Internet would be and how it would impact almost everything we do? I am not sure we even fully understand the power of this platform today, which has so changed the world and will continue to do so forever.

It is relatively easy for an entrepreneur to launch a crowdfunding campaign and raise thousands, if not millions, of dollars in a relatively short time. This is due to the simplicity and power of the technology built into the infrastructure of crowdfunding platforms and their easy use by millions of potential supporters and investors. Using a web-based crowdfunding platform, you can quickly build a campaign, and using social media and email tools, you can communicate that campaign to an immediate network of supporters and beyond.

As mentioned in regard to other aspects of selling, the Internet and its related technology have helped marketplaces become more efficient. And crowdfunding is no exception. Just as we saw the rise of companies like Open Table, Etsy, Airbnb, and Über, we now have the crowdfunding platforms like Kickstarter and OurCrowd. For some entrepreneurs, crowdfunding will provide the necessary funding for their start-ups.

Several industry analysts forecasted that crowdfunding would reach over $5 billion (project and equity crowdfunding) by 2013. Kickstarter alone has raised over $1 billion for entrepreneurs since its founding in 2009. While that’s pretty impressive, several experts predict that the size of the crowdfunding marketplace over the next few years could quickly rise to over $300 billion, based on forthcoming government regulations. That’s a pretty significant marketplace for investment opportunities and it increases the odds for entrepreneurs.

The Power of Crowdfunding

So, what’s actually driving all these crowdfunding platforms? The democratization of buyers and sellers. Every marketplace needs sellers (in this case, entrepreneurs) and buyers (for entrepreneurs, investors) to be successful. In the past, unless you were an angel investor or venture capitalist in a certain city or region, you simply did not “see” these investment opportunities, or could not invest in the best of the start-ups. For example, how many angel investors or venture capitalists get to privately review those start-up investment opportunities?

As of 2010, there were 462 venture capital firms registered to do business in the United States. With an average of four or five key partners, that’s only about 2,000 people. Similarly, several sources cite there are about 400,000 angel investors in the United States who were active and made investments in small companies during the years 2003 to 2008. Now, compare those figures to just one crowdfunding platform, Kickstarter. They indicate that, since 2009, 5.7 million people from 224 countries have donated money to fund at least one project.

In short, the new investors are here, everywhere. They are you and me, and everyone else who has access to the Internet and some dollars to invest. For entrepreneurs, this presents an amazing new funding opportunity.

AN OVERVIEW OF CROWDFUNDING

Crowdfunding is having a dramatic impact on entrepreneurship. In particular, equity-based crowdfunding will likely fund a large number of start-ups that will result in a new pipeline of crowdfunded ventures. The newer equity-based model of crowdfunding, finalized with SEC rules, will likely permit both accredited (those with $1 million in assets or at least $200,000 annual salary) and nonaccredited investors to acquire shares in privately held businesses in exchange for a portion of those entrepreneurs’ ownership stake.

In the broadest sense, crowdfunding is the use of the Internet to raise capital by way of small investments from a large number of investors. Though it remains difficult to accurately predict the longterm implications of crowdfunding, it will be a permanent fixture on the entrepreneurial landscape. Optimists, such as serial entrepreneur, angel investor, and venture capitalist Alan Hall, of Forbes magazine, see a bright future:

What, then, have these business owners been doing for funding? They’ve been relying on credit cards and home equity loans, funding vehicles that have been severely affected by the struggling economy. So if they can’t get money in those ways, and the banks aren’t going to help them, we need to recognize that crowdfunding, as it grows, will play an increasingly critical role in the entrepreneurial ecosystem, with or without the participation, wisdom and safeguards of more-established investment vehicles.

This is consistent with what many believe will be a fundamental shift in the options available to entrepreneurs for raising capital.

Let’s review the three major types of crowdfunding platforms that exist today: reward, debt, and equity.

Reward

Reward campaigns exemplify “traditional” crowdfunding on platforms like Kickstarter or IndieGogo. In exchange for some reward (a discount, freebie, product pre-order, or other item), individuals contribute money to an organization, project, or company. These platforms are here to stay.

Kickstarter is an online crowdfunding/equity platform where the majority of the funds raised go to the entrepreneurs. If a campaign is successful, Kickstarter takes a 5 percent fee and the funds are dispersed through Amazon payments, which entails another 2 to 3 percent fee. Kickstarter was launched on April 28, 2009. It’s a for-profit company based in New York City, and as of late 2013, it had just 69 employees. But astoundingly, its platform has helped entrepreneurs obtain more than $1 billion since its inception. And the amounts seem to grow larger each year.

When I first heard of this crowdfunding platform in 2010, I did not think entrepreneurs could raise serious amounts of money this way. That changed on May 18, 2012, when the Pebble Watch start-up raised a staggering $10,266,845 even though its goal was just $100,000. An entrepreneur might be able to raise $10,000 to $20,000 from friends and family, but $10 million is way beyond most friends and family. Experts believe the funds raised for the Pebble Watch, a Bluetooth-enabled wristwatch that communicates with a smartphone, were from people just placing their orders in advance for a potentially cool watch.

But are these new “voyeur investors” just flexing their rewards muscles before they venture into the “selective ring” of equity crowdfunding? Here are a few of the reward crowdfunding platforms that every entrepreneur should review:

• IndieGogo: Initially launched with a focus on film, will now do almost anything.

• RocketHub: Launched with more arts projects in mind; also focused on sciences.

• Peerbackers: Launched for innovators and entrepreneurs, now includes young adults.

• Kickstarter: The most well-known and popular, but has a reputed tough review process.

Debt or Lending

When it comes to investment crowdfunding, most people immediately think “equity.” But there’s a whole other side to investment crowdfunding, known as peer-to-peer lending or, more commonly, debt-based crowdfunding. Through this model, entrepreneurs may utilize debt crowdfunding platforms for a loan in return for interest that is due based on the funding agreement.

Similar to bank loans, these arrangements call for applicants to demonstrate creditworthiness, or an ability to responsibly handle and repay debt. In many cases, this poses an obstacle for start-ups, which have yet to fully establish credit. However, if you are generating sales and cash flow, this might provide the right opportunity to finance a future inventory order. With that said, creditworthiness is not the only factor lenders consider, so those rejected by large institutions still have a shot at obtaining funding this way. For entrepreneurs who do acquire loans through debt-based crowdfunding, the interest rates vary so shop around for the best rates and terms.

The debt-based crowdfunding process differs from platform to platform. Generally, you need to submit an application for review. Often, debt crowdfunding platforms outline very specific criteria, so double-check that you are qualified before submitting any information. Some platforms measure the financial risk of a given opportunity as a part of their own project valuation, similar to how other investors might perform due diligence. For this reason, not every application is accepted.

To get started, check out some of these debt crowdfunding platforms:

• Funding Circle

• Lending Club

• Prosper

• Zidisha

• Index Ventures

Overseas, there are many thriving platforms to investigate as well, such as Assetz Capital and Zopa.

Equity

Equity crowdfunding is an amazing alternative compared to traditional sources of funding. It is the collective effort of individuals (investors) who network and pool their money, usually via Internet crowdfunding platforms, to support entrepreneurs by providing investment capital in the form of equity.

Equity crowdfunding can also refer to the funding of a company by selling small amounts of equity to many investors. At the moment, equity crowdfunding is the least developed form of crowdfunding, but that is changing rapidly. Once the proposed SEC rules are finalized, this area of crowdfunding could explode.

The new equity crowdfunding rules proposed by the Securities Exchange Commission were a long time in coming. Equity crowdfunding first saw the light of day as a provision of the JOBS Act, which was passed and signed into law in April 2012. While these rules will be finalized in 2014, here are some of the early suggested rules proposed by the SEC in October 2013:

• Start-ups cannot raise more than $1 million in any 12-month period.

• Investors with annual incomes or a net worth below $100,000 can only invest $2,000 or 5 percent of their annual income or net worth, whichever is higher.

• Investors with annual incomes or a net worth above $100,000 can only invest up to 10 percent of that annual income or net worth.

• Transactions must be conducted through an intermediary. Intermediaries include registered brokers or a new type of entity called a “funding portal.”

This new fundraising method will most likely be used by early-stage companies looking for initial capital to fund the start-up, and not all crowdfunding platforms will offer this type of fundraising to entrepreneurs.

The move toward equity crowdfunding is exciting for start-ups and entrepreneurs, who now have an alternative to traditional venture capital. Some of the equity crowdfunding platforms that you should review are:

• OurCrowd

• Grow Venture Community

• Micro Ventures

• Angel List

• CircleUp

There are quite a few more. Do your due diligence; utilize your network and select the platform that you feel will help you succeed.

CROWDFUNDING CAMPAIGN TIPS

After reviewing successful crowdfunding campaigns on both rewards and equity-based platforms, I can provide some insights and tips that may help you better prepare for your crowdfunding opportunity.

For Reward Campaigns

Crowdfunding platforms specializing in projects or rewards like IndieGogo or KickStarter could be an amazing fundraising strategy for entrepreneurs. Review the platform and their rules carefully. And if you do proceed, study other successful projects. Expert advice includes creating a video and using social media vigorously. Here are some key tips to get you started:

1. Give people a great story. If you are going to raise funds to produce a product or service that you are passionate about, then tell them a great story. Put some passion into it and a bit of personality. Don’t go over the top, but give them an “emotional” reason to support you.

2. Set your funding goal carefully. Get the funding you need to launch and test the new product or service. Some small start-ups set reasonable goals of $10,000 to $40,000 and achieve their objective. Others go for $75,000 and only raise $47,000 and so they receive nothing (you have to hit or pass your goal to receive the funds).

3. Create a great video. Videos seem to be one of the top reasons people decide to fund a project. Don’t be an amateur and use your iPhone or webcam. Find someone qualified, a film student or a freelancer, and create a compelling video with some creativity and personality.

4. Design a set of rewards that make sense. Some entrepreneurs think that by having 37 reward levels they will cover just about every possible funding scenario. No. Simplify to just 10 rewards or fewer that are easy to understand and, more important, that you can fund.

5. Prepare your production plans ahead of time. If you are using a manufacturer to help build your product, plan ahead of time to use your campaign funds once you have them. Get multiple bids and understand the production and shipping time lines.

6. Spread the word online. Entrepreneurs need to create word-ofmouth awareness that goes beyond your friends and family network and that you can reach via online marketing tools. Research ahead of time and identify blogs, websites, LinkedIn groups, and the like where you can spread the word.

7. View your email campaign as critical. Take the time to craft a strong set of emails (at least five to seven ahead of time) that will simply but powerfully tell your story. Provide links to your crowdfunding project and your video. Provide updates on how the project is doing. Use a simple but emotional close. Give supporters a reason to care.

8. Welcome your new job. Entrepreneurs frequently underestimate how much time they need to spend on their 30- to 45-day campaign. It’s a full-time job that needs to be cared for almost every day. Put in the time and reap the rewards.

9. Backers are supporters, supporters are backers. Once you have people funding your project, keep them engaged. Constant updates, maybe some behind-the-scenes photos or videos of the product development—anything to make them feel special so that they spread the word to other potential backers in their own networks.

Reward or project-based crowdfunding platforms are amazing things. Where else can you raise money or pre-sell your product, perhaps raise $50,000 or more, and not give up any equity or incur any debt? Entrepreneurs, take advantage of this crowdfunding platform if you can.

For Equity Campaigns

Equity-based crowdfunding is bringing entrepreneurs a brand-new group of investors and is changing the way early-stage capital is invested in given industries. This new way of funding will enable entrepreneurs and investors to connect quickly. While there are many benefits, such as going to market faster, having more investors to pitch, and greater potential strategic relationships, let’s examine how to build a solid equity crowdfunding campaign.

1. Pinpoint your lead investor: Most of the investing crowd will follow a lead investor, so focus on cultivating and closing a lead investor whom others will respect or trust. If you’re fortunate, some of your early investors are either well known or their credentials will establish some social proof when recruiting additional investors. Move on to lesser-known investors only after you have your lead investor locked up.

2. Protect your equity: Don’t give up too much equity if you don’t have to. Just because you’re new to the process, that doesn’t mean you have to comply with unfair requests. For example, some investors may ask for board seats. Unless the investor is hugely strategic or invests more than 50 percent of your target amount, think long and hard about such requests. Ask the investor if he or she would like to help you in an advisory role.

3. Step wisely in the crowdfunding jungle: Equity crowdfunding, however it develops, will be closely regulated and monitored. If you’re raising money by offering equity through one of these platforms, you’re required (or the platform is) by law to verify that the investor is accredited (rules still being finalized). Some entrepreneurs are using third-party companies that offer a certification service to identify accredited investors. This could be a significant time-saver and can keep you in compliance with the SEC.

4. Spend your time well: Manage your leads based on this simple formula: after a couple of emails and conversations, estimate the chances your prospective investor will invest. Prioritize your time and focus on investors with the best potential. Avoid investors who are overly concerned with near-term profitability rather than in building a brand and capturing market share quickly. Long-term strategic investors who have industry or marketplace connections are the best possible investors.

5. Communicate frequently and well: Investors don’t like to be kept in the dark or be surprised. Send investors frequent updates about investments, major endorsements, any positive public relations, and potential news on product concepts or prototypes. Most crowdfunding platforms have automated tools you can use. Also send personal emails for good measure to smaller groups and to specific investors with more details than public “status updates.”

6. Solicit feedback often: In addition to your investment, potential investors might be reviewing quite a few deals. Many have launched successful businesses and some have even had successful company sales or exits. Sometimes it’s best to ask for advice before you ask for their money; a good investor will let you know if he or she is interested. By soliciting valuable feedback, you’re sure to avoid wasting each other’s time. Even if you don’t get a check, at least you’ve increased your odds with the next investor by improving your pitch and presentation.

7. Build trust and confidence: Hone your people-facing and speaking skills. If you need to take a public speaking seminar, do it. You must build rapport with investors. Investors have to believe in you, and that’s directly reflected in how much you believe in yourself and in your company’s potential. Good investors can smell uncertainty and hesitance, so don’t think that you can fool them. Be honest, sincere, and passionate.

THE BENEFITS OF CROWDFUNDING TO AN ENTREPRENEUR

As an entrepreneur, you are looking to create a start-up company. There are a number of important benefits that crowdfunding offers you.

Greater Access to Capital

At an early stage, you may think that outside of your own network, you can raise capital only from accredited investors, venture capitalists, and banks. Crowdfunding is a great alternative way to fund a venture, and it can be done without giving up equity or accumulating debt. The crowdfunding platforms allow you to raise funds from the investor community in exchange for simply providing tangible products or equity.

A Way to Hedge Your Risk

Starting up a company can be a very risky and challenging journey. Besides finding sufficient funding, there are always expenses that are impossible to forecast, challenges in market validation, and other people who want a piece of your venture to help get it off the ground. Utilizing crowdfunding hedges these risks and serves as a valuable learning experience. Crowdfunding as it is today allows you to gain market validation and avoid giving up too much equity before going all out and taking a product concept to market.

It’s Also a Marketing Platform

An active crowdfunding campaign is a great way to introduce your start-up company’s overall mission and vision to the market, as it is a free and easy way to reach numerous customers. Quite a few crowdfunding platforms incorporate social media tools, making it painless to get the word out to prospective customers or investors. This provides the potential to receive thousands of “organic” visits to your website from customers and potential funders. These users are also important for viral marketing, as they have the ability to share and spread the word to their network connections.

It Provides Proof of Concept

Showing potential customers and investors, and convincing yourself that your venture has received sufficient market validation at an early stage, is hard. However, crowdfunding makes this possible. The first question that any subsequent angel or institutional investor will ask will often be along the lines of proof of concept, and a good way to gain some respect and credibility is to show them that your venture had a successful crowdfunding campaign. This instills trust and integrity toward a venture in its early days and potentially validates the opportunity.

It Offers Crowd Brainstorming Opportunities

One of the biggest challenges you as an entrepreneur face is to be able to cover all the holes that a start-up might have at an early stage. By having a crowdfunding campaign, you engage the crowd and receive their comments, feedback, and ideas. This feedback is extremely valuable, as it can help you uncover some aspects of your business proposal that were previously unthought of. It could also inspire new ideas for the product or service and improve the opportunity for success.

It Builds a Loyal Customer Base

A crowdfunding campaign not only allows you to present a business and a product, it also gives you the ability to share the message and the purpose behind it. People who view your campaign and decide to contribute or invest are people who believe in the success of your company in the long run. In essence, these people are early adopters. These early adopters are important to every business, as they can spread the word and assist in the future success of your company.

It’s Free Public Relations

The momentum created by successful crowdfunding campaigns attracts other advisers and potential investments from traditional investors, as well as attention from the media. Success stories make for interesting reading, and writers are always looking for them. Crowdfunding is unique and interesting in these early days, and countless entrepreneurs who have been successful with it have seen larger success and exposure as a result.

It Brings in Pre-Consumer Sales

Launching a crowdfunding rewards campaign gives you the ability to pre-sell a product or concept that you haven’t yet taken to market. This is a good way to gauge customer and marketplace reaction and analyze the market to decide whether to pursue or pivot on the opportunity. Also, in a rewards campaign, the excess funds generated (your revenue versus the cost of the product) are yours to keep and use as you see fit to grow your start-up.

It’s Free

On all-or-nothing crowdfunding platforms (meaning that you get the funds raised only if you reach 100 percent or more of your funding goal) there are so many benefits and usually no fee to participate. If you set a goal and don’t reach it, there is usually no penalty. If you reach your goal, most platforms charge between 5 and 8 percent in total fees. For an equity crowdfunding platform, they likely take a fee of 10 to 15 percent on the capital raised from investors. This may change as equity crowdfunding platforms become more competitive in the future.

THE FUTURE OF CROWDFUNDING

I was asked in a recent interview if I felt that, in regard to crowdfunding, investors would be fleeced by aggressive entrepreneurs. My reply was simply: “Investors who don’t do their homework always risk losing their investment. But what qualifies just a handful of angel investors, or even venture capitalists that are located in certain regions of the country, to be the only ones looking at early deals? Why can’t these deals be pitched online and investors from all over the United States, or world, make a micro investment in the next Google or Pebble Watch regardless of location?”

In the next few years, you will see hundreds of investment firms rushing to offer crowdfunding equity platforms. Perhaps even some super angel investors, venture capitalists, and private equity funds will establish their own platform so they can make micro investments in early-stage companies. In time, things will settle down and crowdfunding will flourish as a major alternative source of funding. If the expert predictions are even close to correct, calling this a $300 dollar marketplace, then you as an entrepreneur might be better able to raise more money and give up less equity in this new open marketplace.

ENTREPRENEUR INSIGHT

Since 2009, three young would-be entrepreneurs named Coby, Mike, and Braydon have been exploring and tinkering with elements of 3D printing, including the rendering software. An engineering student, an entrepreneurship student, and a young firefighter, respectively, they all pursued a passion for tinkering. And 3D printing caught their eye and imagination. But they could not understand why everything was so expensive. Almost cost-prohibitive. So they looked to learn from others and share what they had learned.

At one point, based on their research, it became evident that no one in the emerging industry was interested in building a low-cost 3D printer that most people could afford. So that became their goal. Enter Kickstarter. They created a Kickstarter campaign and set a goal of $49,000, and hoped for the best. They got the word out and received quite a bit of public relations. Their campaign closed on February 1, 2013, having raised $649,663. Since then, they have prototyped their printer and are testing it with potential customers.

KEY TAKEAWAY

You have several options to secure funding for your start-up. Examine your options carefully and then choose the best one for you. Investigate the new crowdfunding platforms as at least one of those options might be viable for you. That way you get the funds you need and keep as much equity as possible.