Synopsis: Equity crowdfunding is touted as an alternative to venture capital for startups seeking to raise money. This article weighs up the pros and cons of crowdfunding vs venture capital. By the end, the reader will be able to make up their own mind which method makes most sense for them. The conclusion points out that it can even be possible to adopt a hybrid approach.
Funding Options – For Unicorns
A company which achieves a valuation of at least US$1 billion is known as a “unicorn” in startup lingo. To have a chance of making it to this magical figure, they need to have great scalability potential, disrupting existing markets or creating an entirely new one. Software, fintech, biotechnology, and medical devices are the sorts of industries that tend to breed potential unicorns. They are high risk, capital-hungry, innovative young companies looking at fast growth, with a chance of a lucrative exit if they are successful.
Such companies are the targets of venture capital (VC). But they can also do well with equity crowdfunding. You might want to first refer to this article if you need to know more about how does equity crowdfunding work.
What follows is a fair comparison between crowdfunding vs venture capital, so that a startup can make an informed choice about which method will best suit them.
“There are times where a startup would be better with angel or VC funding,” admits Yannig Roth of WiSEED, “If your business is not the kind that can expect much traction from a public campaign, or if the benefit your company offers is tricky to explain in a sharp and crisp manner, it could be a lot of effort better spent on talking to financial investors. If you have a great company being highly sought by VC, you could get the money with less effort. But don’t forget that crowdfunding offers more than just the money – it offers engagement, visibility and advocacy too”.
The marketing effort is much larger in crowdfunding vs venture capital, and if you can get money quickly from a financial investor, then that saved time can instead be put towards other business efforts. This saving may tilt the balance in favor of the VCs – so you can get back to actual value creation rather than fundraising.
A Culture Clash?
Before equity crowdfunding, venture capital were just about the only ones willing to take a risk on early-stage companies. Those who get a venture capital investor on board gain a valuable partner, along with their money. This active role is one reason why some companies still prefer venture capital to equity crowdfunding; they get to deal with a small number of large investors, who are highly incentivized to drive the company forward.
For a lot of startups, though, the idea of a financial investor is anathema to their company culture. Alicja Chlebna runs Naturalbox, which delivers ethical, organic snacks, health and beauty products.
“No banker would share the passion I have for my business. And most venture capitalists are pretty arrogant, greedy and difficult to work with, from what I know.”
Strong words, but Alicja isn’t alone in feeling this way.
Now, let’s be clear that not all venture capitalists fit this description. There are a lot of great people in VC that generate win-win environments for themselves and the companies they work with. But nonetheless it must be said that the industry is still mostly male, and tend to come from similar backgrounds — elite universities, and the corporate world. It shouldn’t be surprising that among the melting pot of diversity that entrepreneurs represent, some won’t gel well with people from this “VC culture.” And these entrepreneurs are not necessarily less worthy of being funded – but until now, if they needed funding, they haven’t had much choice but to submit themselves to a culture they don’t identify with. Retaining full control of their culture is one of the real advantages of raising money through crowdfunding vs venture capital.
What other factors need to be weighed when making the choice between equity crowdfunding vs venture capital?
More Open Access
Mark Hughes of Tutora had this to say about their efforts to reach out to venture capital: “They are incredibly hard to access. The main pushback was we were too small – even though we had real customers and real revenue, they were just looking for something bigger; those who are looking for millions of pounds. The other pushback we had was ‘we don’t know who you are.’ Venture capital in London is very much a closed, old boys shop. They only want people coming to them who have come with a recommendation. It makes it really hard if you come from somewhere like the north of England where there’s just not a lot of venture capital activity going on.”
Sandra Rey’s attempts to reach out to venture capital were frustrated by the fact Glowee didn’t seem to fit with any firm they approached. “We have a very new and disruptive product – Glowee uses biotechnology to generate biological lighting. But when we were going to biotech venture capitalists, we were told that we weren’t purely biotech enough. When we went to cleantech funds, they said they didn’t help with companies in the biotech space. Glowee just didn’t fit with the parameters they had already decided on.”
There is far more flexibility in crowdfunding vs venture capital – including the fact that the type of business needn’t be a “unicorn” type of company at all. It could be a local business – without huge scalability potential, but worthy and profitable nonetheless.
Better Outcome On Valuation
Because the power dynamic is more in the company’s favor with equity crowdfunding, the balance of evidence suggests that higher valuations are indeed being achieved.
Venture capitalists are highly experienced in making investments. It’s what they do. When it comes time to talk numbers, they have a massive skill advantage over company founders who may be complete novices, or have been through it a handful of times at most. When the valuation is being negotiated, they feel like they’re playing against a chess grandmaster, when they barely know the way the pieces move.
You may have heard financial investors bemoaning the valuations being achieved in equity crowdfunding as “unrealistic.” It’s hard to know whether to take these complaints seriously, or dismiss them as vested interests protecting their patch – the same way the traditional taxi drivers protest the advent of Uber.
“How awful to think the VC’s position as the exclusive source of capital is being disrupted. Is it ironic that technology will eat its own creator?” – Howard Marks of StartEngine Crowdfunding.
Better Outcome On Investment Terms
One of the most important ways that venture capitalists make money is through the terms they insert into the deal. “The terms from venture capital are always restrictive,” says Laurence Cook of Pavegen. “They want board seats, control, liquidation preferences, restrictive terms on the founders – all things which don’t favor the company raising money.”
Laurence Cook continues:
“Venture capital firms make their money by negotiating hard. That’s their job, and they are very, very good at it. So of course, they are always going to push the valuation down because it gives them more upside. By raising money through the crowd, we were able to raise the money on our own terms.”
These restrictive terms serve to protect the VC’s downside while still offering them many multiples of upside, often at the expense of the founders. It seems like they want to have it both ways – and, indeed, that is exactly what they want. Again, founders can try to negotiate, but their position is weak – they need the money, and they are afraid of the VC walking away.
By contrast, one of the advantages of equity crowdfunding vs venture captial is standardized documents which efficiently manage the real need for preemption rights and avoiding dilution … but in a way that is fair for both founders and investors.
One of the main reasons to conduct an equity crowdfunding offer is to build awareness of a company among new consumers. What is often overlooked is how effective crowdfunding promotion can also be for getting introductions to new suppliers, board members, and other partnerships. When you put your company out there in such a public forum, people can notice and be attracted to your company in so many ways. The ability to put your name out there to the world through a public equity crowdfunding campaign can be a game-changer through the exposure it gives. Conversely, a deal with financial investors is done behind closed doors.
Remember, though, that publicity can be a double-edged sword. It is great if your offer succeeds, because everyone will see that. But similarly, equity crowdfunding failures will be there in the public arena for all to see, while a failed deal with financial investors will never see the light of day beyond the boardroom. If you don’t want to risk a public embarassment, then crowdfunding vs venture capital is definitely riskier on the crowdfunding side.
Broad Shareholder Base
An enlarged shareholder base can provide new passionate shareholder advocates.
Venture capitalists are also shareholder advocates, through the networks and introductions they provide. But, for the sheer number of advocates, equity crowdfunding wins hands down. Imagine having dozens, or even hundreds, of new people who are incentivized to look out for your interests, because your financial interests are now the same as their financial interests! Your network is far larger with crowdfunding vs venture capital.
Fragmented Shareholder Base?
Another point needs to be addressed here, which is the fear that equity crowdfunding will make a company less attractive to financial investors in the future, due to a large number of shareholders making the share register “difficult to deal with” for potential future buyers.
“There’s certainly a group of crowdfunding non-believers in the venture capital community, but there is an increasing percentage who are buying into it. In some cases, they are even combing through the crowdfunding platforms, as a way of finding new companies to invest in.” says Bret Conkin of Crowdfund Suite.
There will always be some people who don’t like dealing with new ways of doing things, but something like the share register is a very minor thing that can be worked out, if needed. Ultimately, business performance matters more. If your business is going well enough, financial investors will look past a messy register, or find a way to restructure things.
Skai Dalziel of Guusto makes a great point: “The bigger risk is not having a successful company. The goal is to get to an operating business that generates profits. If crowdfunding is a way to get there, great.” In the future, you would much rather have a business, even if financial investors show resistance to it because it has been funded through crowdfunding. It’s better than having no business because you failed to get the funding you needed!
Crowdfunding vs Venture Capital – Or Working Together?
When founders think equity crowdfunding, typically they are envisaging having investors who don’t bring anything to the business apart from their money. When weighing crowdfunding vs venture capital, i.e. bringing on board a single financial investor that promises to lend their time to the business and help drive it forward, founders become sold on this idea of having this “smart money” on their side.
But when a company runs an equity crowdfunding campaign, large investors aren’t excluded! Far from it. In fact, the platforms will encourage you to bring on financial investors as part of your raise.
A crowdfunding raise of $1 million may consist of one investor putting in $300,000, two contributing $100,000 each, six doing $25,000 each, and the remainder in smaller amounts. That investor who contributed $300,000 may very well be the sort of person you might want to add to your board of directors and lend the same kind of expertise you envisaged from a smart money investor. Crowdfunding can be as well as smart money investors, not instead of them.
Tom Britton of SyndicateRoom points to the efficiencies that crowdfunding platforms can bring, even to the process of getting new large investors to commit. “In the ‘old days,’ when a round needed to be filled by several angels or VCs, each new investor would try to re-negotiate the valuation, go over the terms again and try to get preferences over the others. It was just a pain. By bringing that process online, once a company finds their first investor, they put the terms on the platform, and any investors that come afterwards must agree to the terms originally set.”
So crowdfunding vs venture capital doesn’t need to be “either / or”. Both sorts of investors can participate at the same time – getting a lot of the best of both worlds!