One of the greatest benefits of the internet age has been the breaking down of barriers. Internet based real-time communication has broken down barriers of distance, social networks have eliminated the constraints of first degree relationships, online marketplaces have removed the layers of middlemen between vendors and consumers, cloud computing has lowered the cost hurdle of developing and deploying software, the blockchain promises to circumvent centralized intermediaries and the inherent global reach of the internet (2.8+ billion users) has made barriers to content distribution a thing of the past.
Crowdfunding is one of the latest internet trends that follows in this spirit. Capital has historically been one of the most difficult things to access for large percentages of the population. Most individuals are repeatedly unsuccessful in their attempts to secure a loan to cover personal expenses, raise money to expand a small business, or bring in external funding to help get an innovative idea off the ground, running into walls at every turn. These walls come in many forms (geographic or demographic disadvantage, lack of influential relationships, cost, etc.), but are all emblematic of a systemic imbalance of power between the sources of capital and those who need it.
One glaring example of this is the world of venture capital. Getting a startup funded through traditional sources of venture capital has become largely contingent on who you know and where you live.
Most VCs will unabashedly tell you that your only chance of getting funded by them is if you approach them through a warm referral (i.e. an introduction from a mutual friend or colleague). The rationale for this less-than-democratic approach is that if entrepreneurs cannot leverage their personal networks to navigate their way to a warm referral, it means that they lack an important entrepreneurial skill — the ability to get to people. Given the unmanageable volume of inbound deal flow most VCs receive, a large percentage of which is low quality, it is completely sensible to use the deal source as a preliminary filter. However, I have never seen data to support the claim that the ability to find a mutual connection to a particular VC is the greatest predictor of a startup’s success. In theory startups should get funded based on who is most likely to succeed, with networking ability being just one of many criteria considered. It seems imperfect — driven more by human process related constraints than ideology — that this, of all criteria, should be the gating criterion for raising capital. The extremely well-accomplished Bessemer Venture Partners famously flaunts its Anti-Portfolio (a hindsight view of all of the great companies that they chose not to invest in including Google, Facebook, Apple, Tesla), but who knows how many missed unicorns would be on VC lists of “We wouldn’t know because they never got a warm referral to us.”
As far as the importance of ‘where you live’, this assertion is supported by the data: taken together, the top five states (California, Massachusetts, New York, Connecticut, and Illinois) hold 81.1% of total venture capital in this country, essentially the same as a year ago, and in 2013, 70% of total invested dollars occurred within only 3 states: CA (50%), MA (10%) and NY (10%). California-based firms invest 2/3 of their investment dollars within California. VCs have a solid rationale for this as well, being located closer to your portfolio companies makes it easier to provide ongoing support post-investment. Regardless of the reason, the reality is that the odds of raising venture capital are strongly stacked against you if you live outside of one of the geographic hotbeds of VC activity.
The current paradigm is not a knock on VCs, who have valid reasons for this behavior and who do much more for their portfolio companies than provide capital, but crowdfunding is not constrained by these same limitations. Crowdfunding tears down these walls.
By giving innovators a platform to approach a global, growing audience of potential financiers, crowdfunding drastically alters the supply/demand power dynamic of private capital markets. Those in need of capital can now turn to a diverse audience of capital providers who possess a wide range of preferences as far as passions, interests and investment strategies — making the likelihood of finding a match and raising money far more probable.
Since Kickstarter’s launch in 2009, more than $1.4 billion from 8.5 million individual backers has gone to fund 83,000 creative projects. That is 83,000 projects that may have never been funded but for the emergence of crowdfunding. This trend shows no signs of slowing down either: according to the The State Of Hardware Crowdfunding In Q1, the $70 million that went to crowdfund 128 hardware projects in the first quarter was about 35% of the total dollars hardware projects had raised since Kickstarter and Indiegogo launched over 5 years ago. My own personal experience mirrors this trend. Prior to Kickstarter I had never contributed to a friend’s creative experimentation or pre-purchased a consumer electronic. Now, several hundred dollars poorer (including backing Scio, Coolest Cooler and Zuta Labs), I can confidently say that Kickstarter and Indiegogo are expanding the pie of innovation capital in a meaningful way.
This is not to say that every innovative idea is deserving of funding. Kickstarter campaigns have an overall success rate of 38.28% and technology projects specifically have raised $230 million while enjoying a 21.91% success rate. While there are most likely other contributing variables, at a basic level this seems to indicate that projects and companies are being funded on the basis of who is most deserving (which has led to success stories like Pebble and Oculus VR).
Killing Two Birds with One Stone
Equity crowdfunding sites like OurCrowd and AngelList are taking this disruption one step further by not only breaking down barriers for entrepreneurs but for investors as well. These companies have gained significant traction by giving investors around the world access to a new asset class previously only available to large institutional investors and experienced angels. Remarkably, in less than 3 years since launching, OurCrowd has active investors in 37 different countries.
The key to disrupting the way that startups are funded has been the democratization of both sides of the marketplace (i.e. investors and entrepreneurs). OurCrowd’s CEO Jon Medved believes that by opening up opportunities to investors from around the world, OurCrowd, which has received deal flow from 46 different countries and made investments in 6, is breaking down the geographic barriers that plague many start-ups, particularly those in areas where VC funding is not plentiful.
“Crowdfunding in the equities side is going to be the real game changer, because this is going to allow a notion of the geographically privileged entrepreneur to fade a little bit,” he says.
What It Means
Crowdfunding in its various forms has emerged as an extremely powerful engine for good, for innovation and for economic growth and shows no signs of slowing down. At a fundamental level, crowdfunding is a demonstration of the power of openness and leveraging distributed resources. Whether it is capital, ideas or content — crowd businesses are forcing us from behind the closed walls of our respective silos and ushering in a new era of open, meritocratic platforms where the best companies get funded, the best products designed and the best ideas pursued. When it comes to this trend, we will be looking to put our money where our mouth is. Stay tuned.