How is ‘crowdfunding’ the new venture capitalism, or even way better?

How is ‘crowdfunding’ the new venture capitalism, or even way better?

Once upon a time, entrepreneurs had one primary course of action if they wanted to realize an idea. First step: go door-to-door looking for financial backers – and face a good share of rejection along the way. Step two: spend a fair amount of seed capital on the expense of prototyping. Going to customers was the last step of the process. And because products were taken to market without knowing exactly how consumers were going to respond, more funds would need to go towards marketing to build awareness. 

Crowdfunding is an industrial revolution in that it flips the Venture Capitalist (VC) fundraising model on its head. Sites like Kickstarter (US), Seedr (UK), and KissKissBankBank (France), let entrepreneurs go directly to their potential clients early on in the development phase – and find funding and market validation in one fell swoop.

This is great news for the dreamers – fundraising for a start-up is now easier than ever. However, the crowdfunding model still has some major hurdles in its path:

Fundraising is one thing, scaling another

The most important transformation for start-ups as they move from the VC fundraising model to the crowdfunding model, is that logistics and production appear downstream.

How will the product be produced on a large scale? What shipping methods will be used? What happens with defective products? What recourse will the business have if there are health or safety concerns? These are some important questions that VCs typically address before investing, and risk becoming an afterthought with the crowdfunding model. But solutions to this problem are emerging, for example, many companies like Shipwire are offering scalable logistics support to crowdfunded businesses.

Still, many crowdfunded projects quickly realize that fundraising and market validation are one part of the equation – meeting the needs of hundreds, and sometimes thousands of backers is quite another. This explains why 75% of Kickstarter funded products today ship late, to the frustration of many backers. In dealing with this issue, Kickstarter has gone so far as to come up with a new motto – “We’re not a store”. In fact, this clarification really underscores the pretty blurry image we have of the “crowdfunder”.

Who are crowdfunders, anyway?

The “we’re not a store” line was designed with a specific kind of crowdfunder in mind – the consumer who is simply pre-ordering a product that he or she hasn’t yet found on the marketplace. With Kickstarter this relationship is straightforward because backers are eventually rewarded with a copy of the product, ahead of large-scale production.

However, other backers invest in an idea because they’re truly passionate about it and believe in its potential for success on a more personal level. They show their emotional attachment by giving more than the future ticket price of the item, sometimes much more. Their contributions are a sign of love and trust.

But between these two ends of the spectrum – those backer who are pre-ordering out of self-interest and those backers who are more altruistic in their support - there are all kinds of nuances.

At the end of the day, crowdfunding is more about creating a sense of community than just simply identifying future consumers.  And although it’s best suited for the start-up phase, crowdfunding practices can even help established companies build this kind of community and reach out to a wider audience.

What do they expect from their investment?

When a VC invests in a start-up, their objectives are clear: they want a stake in the company and a say in the direction it takes. They’re looking to grow a business and get a positive return.  

This relationship is less clear with crowdfunding where the return on investment isn’t always easy to define. For example, when Oculus Rift was acquired by Facebook for 2 Billion, it left many of its kickstarter backers feeling betrayed. Platforms like Crowdcube offer two-way contracts between the entrepreneur and their backers. However, investor relations are complicated at the best of times, let alone when hundreds of financial backers come into play.

Crowdfunding is a great way for businesses to get cash without diluting equity – in other words, you no longer need to give those investors a stake in your company, you can simply ask that they pre-order products in order to ensure the viability of the business. In a sense, the reward of taking risk through equity is now transformed into a reward for motivated consumers to be the early support and first users of “Insanely Great” products--as Steve Jobs use to describe Apple early products.

In the old “push” economy, “tentatively great” products required early professional investments to account for later marketing patch when the product needs to be pushed down the throat of customers. By combining the best of Lean venturing and web 2.0 tools, crowdfunding allows to move towards a push economy where great vs. less great get sorted out earlier, in a direct relationship between customers and entrepreneurs.

If you’re debating on whether or not the crowdfunding rout is right for you, ask yourself these questions:

  • Are you in the start-up phase? Although crowdfunding can be a great way to build a community around more developed enterprises, it’s most effective early on in the life of a start-up.  
  • Will the public connect emotionally with your idea? You will be looking for the support of a kind of extended family – so backers are going to need to emotionally connect to the project. Many businesses looking to crowdfund first invest in a video or other social media tools to explain their project and get future investors fired-up.
  • Will your business idea lend itself to lean principles? You should be able to produce a first prototype with a 3D printer, for example, and first batch of production with minimal upfront costs. 
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