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Crowdfunding…a threat to Venture Capital?

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Crowdfunding is a very recent phenomenon and is growing strongly now, albeit from a small initial base. In this post we look at what crowdfunding is and whether it’s a serious competitor, a valid alternative or complement to traditional sources of capital. In future posts we will look more specifically at equity and debt crowdfunding markets.

Briefly let’s divide the market:

Donation-Based

In donation-based crowdfunding, the funds are collected from the community for a publicly disclosed initiative but there is no financial return for the people putting the money in. In some cases there are small rewards such as discounts, books or free tickets but in other cases goodwill is the only reward, as it is not a traditional investment.   They have had explosive growth in this sector with the market and it has been branching out into such areas such as community development such as Citizen Investor.

Investment-Based

These originally sprung as an off-shoot to the donation based market and a number are based on pre-purchase of products  where substantial funds have been raised to fund a specific products. For example, a fitness bracelet, Amiigo, raised over 500k for product development.  These sites have evolved into actual equity driven investment platforms and along with the growth in the overall marketplace, some of them have morphed and many now provide both equity and debt financing.  In terms of debt, this comes in various forms, from mini-bonds to products that are more akin to traditional bank loans. The UK has seen the development of a number of different regulated platforms to facilitate this, ranging from generalist providers such as CrowdCube to more niche platforms such as the Trillion Fund that specifically target green energy.

Growth in Crowdfunding

Crowdfunding has undoubtedly seen tremendous growth in the past few years thanks to advancements in connectivity and availability of internet access as cash moves online. In essence, by removing the intermediary, combined with a crisis in confidence from banks, crowdfunding is better trusted and seen as an easier way to raise capital for a small business which may lack perfect understanding on how to raise the capital initially. One of the key differences in crowdfunding is it is consumer-driven. Therefore, if a consumer wants to see a product, they are effectively investing to have it developed.

A few examples:

  • In December 2013 where a desktop computer that anyone can build and put together (especially good for educating the young) called Kano raised over $1.5 million on Kickstarter.
  • In July 2014, Bug-A-Salt, a toy shotgun that shoots salt blasts to kill insects raised over $500,000 on Indiegogo.

Over the past three years the crowdfunding economy has more than tripled to $5.1 billion and while this may sound large, the market is actually still in its infancy. Today, over £1,700 per hour is being raised in the UK through crowdfunding. On the debt side in the UK, just one site, Funding Circle  has provided nearly £400 million in loans to small businesses.

This infographic give you some perspective on just the growth in the equity crowdfunding space:

Infographic

Crowdfunding for Venture Capital & Angel Investment

Crowdfunding is always viewed as some sort of threat to venture capital and angel investment. However, research from CB Insights suggests that hardware projects which have managed to raise at least $100,000 through Kickstarter or Indiegogo have gone onto raise over $321 million from venture capitalists. Around 9% of the 443 projects that reach the $100,000 threshold on crowdfunding platforms have also raised venture capital.

The Threat

So does crowdfunding actually pose a threat? Well, it would seem not. Instead venture capitalists have taken to embracing the trend and utilising crowdfunding platforms as a tool for identifying strong investment propositions. Peter Moran, a partner at venture firm DCM concluded “We consider that [crowdfunding] is an extremely helpful data point about whether the public wants a device”. In other words, some venture capital firms look out on crowdfunding platforms for the business ideas that gain the most public interest and therefore, investment to measure potential future demand for such a product.

Does debt crowdfunding pose a threat to banks? Again most likely not – mainly because banks through deposits and reserve ration can effectively “create money”. Crowdfunding platforms will never have the ability to do this and get this multiplier effect for the economy.

The Angels

Angels are obviously most at threat from the crowdfunding phenomena as it targets their sweet spot. But a frequent problem for angel investors is getting a sustained deal-flow and crowdfunding opens up a whole realm of possibility in that regard. Similar to above, it allows angel investors to find companies, saving them time and extending their reach, allowing angels to focus their efforts on due diligence. Even better, for the angel investors, crowdfunding sites are increasingly requiring companies to upload diligence materials that are detailed and organized which allows angels to focus on aspects important to them.

The Venture Capitalists

Unlike angels, VC firms are not as interested in deal flow. The primary reason for this being that VC firms have investment professionals whose sole job is to generate deals. Another issue is that VC invest with a barbell strategy; a certain number of companies that will go bust, a certain that will middle along and a few that will bring them outsize returns.  To aid that strategy, most venture capitalist are looking for “unicorns”  ultra-fast moving companies that are growing at rates much faster than the competition –if the competition even exists. However, this leads to a void in the market as many VCs are not interested in backing companies in more traditional markets. Therefore, the crossover between venture capital and crowdfunding is not as correlated as one might expect. VCs are nonetheless likely to engage with crowdfunding regardless to ensure they are not missing any golden opportunities.

Instead, it is likely crowdfunding, rather than competing with VCs, will fill a rather different gap in the market. Industries outside of the venture capitalist favoured technology and bio-tech spaces are likely to be well served by crowd funding.

Concluding Remarks – Is it working?

In short, at White Lake we believe that crowd funding has a place long-term in start-up capital.   Firstly, it’s a new source of capital, secondly, we believe that it allows a wider range of businesses to be funded –if you are not in a high growth or extremely disruptive market, crowd funding provides a different type of capital than traditional angel or venture capital funding.  And lastly, we say this with a proviso that it is neither good nor bad –but highly dependent upon your business, crowdfunding provides capital but it does not provide you with expertise (an Angel or VC sitting on your Board or assisting with operations) although you as a Founder are likely to maintain total control.  As an entrepreneur, you need to have a very honest assessment of the skills that you need as you grow your business.  Even peer to peer lending, will not provide you with the advice and services of a traditional corporate relationship banker.  Capital is always a requirement but so are the specialist strategic skills a venture capitalist can bring to your board. So you may get the money but be sure you also have the correct critical thinking in your overall team.

Author: Ashok Parekh, Director, Investment Services

Thanks to input from White Lake Intern: Will Johnson

 


Crowdfunding…a threat to Venture Capital?