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April 3, 2013

VC funding vs. Crowdfunding - let’s get real

Crowdfunding is all the rage. Even the SEC recently blessed one type of crowdfunding for which there was risk of an enforcement action. Several in the early-stage ecosystem have called for VCs to “up their game,” as alternative paths to financing create competitive threats to both incumbent firms and the venture model itself. I think drawing parallels between crowdfunding and VC investment is both silly and inappropriate and conflates several important factors, most of which have to do with whether a founder is dealing with a good VC partner or a lousy VC partner. There will always be good VCs and shitty VCs from a founder perspective, and the presence of crowdfunding is unlikely to impact this phenomenon. That said, here is the compare/contrast as I see it between crowdfunding and VC funding (assuming one is dealing with a quality VC who acts as a true partner with management). Please note that I am not looking to specifically address of whether crowdfunding may or may not be a good vehicle for accessing early-stage investment opportunities. I will say, however, that if one’s investment thesis generally revolves around the notion of “social proof” than I don’t hold high hopes for this corner of the asset class.

1. Mentoring and assistance

  • VC: High
  • Crowdfunding: Low

With younger first-time founders, I personally believe money is not at all fungible and that there is significant value to partnering with a great individual at a great firm. I have personally witnessed this as a founder, as an angel and most recently as a VC. Whoever says that “all money is green” and that the source doesn’t matter isn’t giving the inexperienced yet visionary founder very good advice. I believe this talk is a function more of ego and bravado than really trying to give a founder the best advice for building a sustainable, long term, profitable business. Cynics will say “Oh, you’re just talking your book.” My response: come back with a thoughtful argument and save the platitudes. I also acknowledge that many founders successfully build a suite of mentors and advisors both inside and outside of their funding syndicates, but I don’t see these relationships as a replacement for a VC operator that has interests and exposures closely aligned with those of the founders.

2. Stability

  • VC: High
  • Crowdfunding: Low

Most seed stage businesses with which I’ve been involved have not been “up and to the right” propositions from the get go. It has taken a bunch of time - invariably more time than expected - to achieve product/market fit and, more importantly, to figure out a scalable and replicable way to sell the product. And with this extra time comes extra financing requirements, often more than the start-up has on hand. Because of this, in purely angel-funded situations (and, by extension, crowdfunded situations where there is no ostensible deal lead with the responsibility and resources to bridge the gap), it is frequently either brutally painful and time consuming or impossible to secure this incremental capital prior to Series A-type metrics being hit. This is only one of the ways where a supportive VC partner can help keep the team focused on execution by injecting enough capital to hit the key operating milestones Series A investors are looking for. And this can generally be done quite quickly and painlessly, but has to be done in an environment of trust and support. It is important that both founders and the VC feel a bridge investment was done fairly and thoughtfully, but this is something that strong VC partners do every day. It’s part of life.

3. Friction

  • VC: High
  • Crowdfunding: Low

As crowdfunding platforms become increasingly turn-key and the information provided becomes better, it will become easier and easier to tap a broad array of accredited investors for start-up funds. VCs, regardless of how streamlined their process might be, will always represent more friction and require more effort in order to close a round. They will ask more questions. Spend more time. Likely distract to a greater extent. But in my experience this process is often healthy for the start-up founder and forces a level of self-awareness, insight, professionalism and transparency that did not exist previously. For more seasoned founders this might not be seen as valuable, and the more streamlined crowdfunding process might be more appealing. In fact, as I see it crowdfunding appears most appropriate in two distinct circumstances:

  1. Where the money raised is to hack together a prototype, and the focus is purely technical and not on business-building; or
  2. Where the money is raised from a seasoned founder who doesn’t value the tangibles and intangibles offered by a VC, and really does view dollars as fungible.
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