Startups Turn to the Crowd: A Promising Revolution in Fundraising, With Caveats

Startups Turn to the Crowd: A Promising Revolution in Fundraising, With Caveats


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Does crowdfunding offer entrepreneurs an easy, gold-paved road to market, or are there hidden risks?


Gioia DeucherGioia Deucher is Associate Director and Head of Startup Services at swissnex San Francisco. While she usually tries to avoid large crowds, she is fascinated by the power of the (virtual) crowds as a source of game-changing ideas and capital. As of this fall, she will be working the crowds in Brazil as the founder and CEO of the newest swissnex outpost in Rio de Janeiro.

Swiss people spent 2.7 billion US dollars on clothing and shoes in 2012. That same amount was raised worldwide last year by more than one million campaigns hosted on crowdfunding platforms (CFPs)—an 81 percent increase over 2011. North America and Europe currently account for over 95 percent of the total crowdfunding market. In Switzerland alone, there are at least eight CFPs, most of them no more than a year or two old.

The Buccaneer 3D Printer from Palo Alto-based Pirate3D, which at $1 million reached 954 percent of its initial fundraising goal just halfway into the campaign, is an impressive demonstration of the power of crowds in turning dreams into reality.

The rise of crowdfunding is impacting government policy and altering the role of financial institutions around the world. While traditionally these platforms were used for social causes, crowdfunding is now gaining ground as an alternative to traditional angel investment in the creation of startups. But does crowdfunding really offer entrepreneurs an easy, gold-paved road to market, or are there hidden risks?

While equity-based crowdfunding is becoming more popular, most CFPs adhere to a rewards-based model. Instead of giving up a share of the company, startups offer project backers virtual or physical rewards, ranging from a simple shout-out on social media to preferred access to the final product.

Photo courtesy of Crowdsourcing.org

Photo courtesy of Crowdsourcing.org

More than Money

Raising seed money to get a company off the ground is a rough exercise for any aspiring entrepreneur. Some compare it to dating: the founder must wear the heart on the sleeve in front of countless business angels or venture capitalists, only to get rejected nine times out of ten. CFPs make this process no less arduous, but at least a voice is given to those who could ultimately benefit from the startup’s idea or product—the people.

 

Innovation cannot be lost to a VC’s inbox. Innovation is too important for one man, or one firm, to pass judgment on… Innovation serves and benefits the masses, and deserves to be judged by them.

- Eric Migicovsky, Founder of Pebble E-Paper Watchone of the most successful Kickstarter campaigns to date.

Market validation on the cheap

There are other reasons for startups to choose crowdfunding over traditional seed finance. In the spirit of the lean startup doctrine, allowing the crowd to validate your product early on is an effective way to test it, collect meaningful feedback, and make changes before rollout. The earlier a startup can test the market, the lower the risk of wasting time working on a product that won’t find resonance.

Brand awareness and pre-sales

Crowdfunding allows an entrepreneur to kick-start a marketing campaign and turn fans into brand evangelists. A crowdfunding campaign, when done well, can put a startup on the radar of bloggers, peers, and competitors who will loathe or love the product but talk about it either way.

Rewards-based crowdfunding—where fundraisers offer a reward for contributions—is also an excellent way to pre-sell products or services. Backers can choose to be among the first to receive an offering in return for a financial contribution, which helps the company mitigate risks and earn capital that can be directly applied toward production and marketing costs. And pre-sales commitments from backers further constitute proof of concept by establishing credibility and market demand.

Image courtersy of Crowdsourcing.org

Image courtesy of Crowdsourcing.org

Beware of the downsides

Pre-sales, however, carries risk. With traditional angel or venture capital investment, a startup effectively receives a sum of money that goes toward building the product, the team, and the customer base. For rewards-based crowdfunding, for now the most common type, there’s no blank check: funds must immediately go toward manufacturing and shipping promised goods.

Add to this the fact that a startup operates in a regulatory environment that’s fraught with uncertainty and that crowdfunding requires no less investment in time than raising venture capital, and you quickly realize that starting up with the help of the crowd is definitely no panacea!

If a startup raises $1m through Kickstarter, that company doesn’t have $1m in their bank account; instead, they just engaged in pre-sales accounting for a large chunk of that amount.

Chance Barnett, CEO of CrowdFunder

Legal and regulatory uncertainty

Crowdfunding is an industry in the making, and the legal frameworks to avoid fraud and protect backers and fundraisers alike are still to be defined. While equity-based crowdfunding—where investors effectively buy a share of the company—is already possible in Switzerland, in the US it has been a subject of great debate.

US President Barack Obama signed a bill into law that paves the way for non-accredited investors to put small amounts of money into startups. The specific rules are yet to be spelled out, but it is likely to transform the US fundraising landscape.

For the time being, crowdfunders are pioneers, shaping a nascent industry with their successes and failures.

No quick fix

Generating traffic and visibility for your crowdfunding campaign isn’t easy. And turning backers into brand ambassadors requires the kind of engagement that cannot be done without a solid commitment of time and resources. As Thomas Steinemann, CEO of the Swiss-based luxury watch company DuBois et Fils and behind one of the most successful Swiss crowdfunding campaigns thus far, told me, “You must not save time or energy when it comes to connecting with shareholders.”

Steinemann responds to each and every request from backers, has met with several of them in person, and currently spends most of his time building and maintaining these relationships.

Successfulcampaign

Delivering on promises

It is not uncommon for crowdfunding campaigns to overshoot their initial fundraising goals by sometimes tens of thousands of dollars. While this might sound appealing, entrepreneurs need to think carefully about the implications of these pledges. In rewards-based campaigns, once people have pledged their cash, they expect something in return. Time and again, teams announce delays and struggle to meet their commitments. I personally pledged to a project over ten months ago and to this day have not received my reward, a simple t-shirt. Cases of bankruptcy have cast a shadow on this industry.

As Kickstarter’s founder Perry Chen wrote last year, Kickstarter Is Not A Store. They introduced new rules to discourage products that are prone to manufacturing bottlenecks.

While Kickstarter has democratized and decentralized the process of raising capital, concerns of manufacturing, shipping and storage still retain the unglamorous grit of the real world.

Kyle Vanhemert, FastCompany Co.Design

So now what?

Crowdfunding sounds easy, and on the surface that may well be so. But successful crowdfunding campaigns generally do not happen by accident. Triumphant projects share several attributes: a solid idea and sellable vision; diligent preparation and careful planning; an appealing reward structure; and effective social media, marketing, and PR strategies as well as ongoing outreach to backers.

Thinking about planning your own campaign? Here’s a list of some of the most useful crowdfunding resources we found:

The biggest failure is not to launch. Do not fear exposing yourself and your project. It is for the best!

Thomas Sarlandie, Founder of Loochi (crowdfunded on IndieGoGo)

Read about how crowdfunding is infiltrating and enabling research on nextrends.


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