One of the hot new approaches I have seen around the country for assisting startups looking for funding has been “crowd support” sites (e.g., Kickstarter) or “crowd investing” sites (e.g., SeedInvest). These are variations on a “crowd-funding” theme to raise money for a startup through social networks and voting at public events. I’m still waiting for a startup to proclaim real success from this approach.
Crowd-sourcing tools, usually Internet applications, use the social media to poll for interest, feedback, and ultimately some funding for the startup. This is a complex task, especially as it involves creating an accurate yet compelling offer, collecting the money, and rewarding the investors.
Crowd-pitching is an offline event, but logically similar, which give several candidates an opportunity to pitch to a crowd of interested people for a couple of minutes, after which the crowd “votes” with some play-money to pick the best candidate, who then wins some nominal investment amount or services.
Certainly, both of these crowd-funding approaches provide the entrepreneur with an opportunity to hone his pitch and get some real consumer feedback on the idea. But from my perspective representing investors, this approach falls short on several counts:
- Focus is on the product, not the business model. When pitching to consumers, online or offline, the feedback will likely be on features and design. The key success factors of the business model (how you make money), management expertise, and financial projections will likely get overlooked.
- Amount of funding provided is very small. The amount of time and money required for publicity and promotion of any crowd-funding activities may be more than the return. In reality, a few hundred or even a few thousand dollars to a few winners, is probably not a return on the investment required.
- Multiple micro-investments are not manageable. Investors know how tough it is to get a set of terms accepted by even two investors, much less hundreds. The administration of legal conditions, signatures, disclosures, and distributions is a nightmare. In my opinion, that’s why micro-finance has rarely worked, even for loans.
- Proposal content is too short to be meaningful. In all cases, to keep non-professionals attention, the content of the offer online, or pitch presented, is very limited. No one contemplates including a business plan, investor presentation, or even the equivalent of an executive summary.
- Crowd sample size and makeup not representative of market. If the pitch is offline, the audience is likely too small and mostly budding entrepreneurs. Even online, the type of people who may respond to social media requests may bear very little relationship to the intended market.
- Investors are not prepared for the high risk of startups. Crowd-funding investors are not constrained to be accredited professional investors. They may not understand that nine out of ten startup investments provide no return, and the risk of securities law violations is very high.
- Intellectual property is jeopardized. Non-disclosure agreements can’t be done in these environments. In an environment populated by entrepreneurs rather than investors, when you are new to the game, you are exposing your plan to your biggest potential competitors.
Some groups are making an effort to mitigate these problems by pre-screening the candidates and providing an experienced panel of investors to do the judging. This helps by making sure the feedback is realistic, and the presenters have a rational business opportunity to present. I’m already working with a couple of organizations along these lines.
Overall, there is no question that crowd-funding makes sense for non-profits soliciting donations, disaster relief efforts, political campaigns, or even artists seeking support from fans. But in the competitive world of “the next big thing,” with millions of dollars at stake to be lost, counting on these mechanisms today for money would be foolhardy.