VC funding is the old standard, well known way of capitalizing a tech business. While it is still appropriate for a small number of mobile software, SaaS and hardware companies, it’s not always understood that startups need to fit REALLY well with the VC model for a successful funding event. More on that later. The much newer Equity Crowdfunding approach opens up capital to a much broader range of technology businesses. There are many companies who need capital and can provide an nice investment return, but just don’t meet the somewhat strict investment criteria of VC firms.
So the first thing to realize is that the choice of fundraising method may not actually be yours! In many if not most cases, if you need the money, you need to take it where you can get it. In addition to VCs and equity crowdfunding platforms, that may include Private Equity, Angel investors or even bootstrapping on your personal credit cards! Let’s now move on to looking at some important considerations which may (if you DO have a choice) push you toward one or the other of these two popular ways of raising capital.
One key definition is to differentiate “equity crowdfunding” from the more generic term “crowdfunding”. There are many types of crowdfunding platforms that serve different audiences and purposes. Crowdfunding originally became popular in the US to raise money for charitable causes, as well as raising money by for-profit businesses which had a mission oriented toward “social good”. These “donation” or “reward” based platforms include such well known names as Kickstarter, Indiegogo and GoFundMe. These platforms may be used for purely charitable donation campaigns, as well as for-profit company’s campaigns offering a variety of rewards for donations, such as a free product from the company raising money.
Equity Crowdfunding platform choices
Equity crowdfunding is therefore a more specialized form of crowdfunding which provides equity in a company in exchange for investment. These platforms typically conduct the investment process totally online, in an analogous fashion to buying products online from an eCommerce platform. These equity crowdfunding platforms conform to a variety of US investment regulations including Reg CF, Title III Equity Crowdfunding or Reg D, suitable for raising small or large amounts of money. Well known US-based Equity Crowdfunding platforms include StartEngine, SeedInvest, and MicroVentures, among many others. In Europe, some well know Equity Crowdfunding names include FundedByMe (Sweden), Companisto (Germany) and Invesdor (Finland). In Asia take a look at AngelCrunch (China), Yinc (South Korea), Investable (Hong Kong) and MoolahSense (Singapore).
Equity Crowdfunding vs. VC funding criteria
The first thing I would advise is for you to actually identify your goals! What are you trying to accomplish by raising this round of funds? Get to a working prototype or beta application? Reach breakeven? Obtain an investor partner who is very important, for reasons other than the money itself? How much money do you need? Are you trying to fund a “rocket ship”, or maybe a more modest vertical SaaS business in a niche market? It’s important to answer these types of questions upfront.
Fundraising is by definition a strategic activity; you need to develop a strategic plan for the activity before you consider the method of implementation. So don’t skip this step and take the planning seriously. Do your planning well and it will go a long way toward leading you to the right funding methodology. This could include angel funding, bootstrapping, private equity funding, etc., in addition to the VC and equity crowdfunding approaches being discussed in this article. I wrote more on Strategic Fundraising here.
Market size and potential
On the VC funding side it’s pretty simple, and surprisingly, poorly understood by many tech entrepreneurs. Everything needs to be big when dealing with VCs. The market size/potential in particular needs to be outsized, preferably a billion dollar or larger. The potential return on investment for the VC needs to be in the 10-100x range to interest most venture capital firms. Usually this also means large investment rounds, as well as large and rapid staffing up at the startup. By the very nature of the way VC firms operate, they usually believe that they have to “write large checks” to operate in an efficient manner.
Equity crowdfunding is far more flexible than VCs. Nearly any size or stage of business can do an equity crowdfunding round. Investors range from accredited individual investors to institutional investors. Due to the wide range of potential investor profiles, it is much easier to design and raise a round that fits your individual company, timing and market potential, than when going directly to an institutional investor such as a VC.
B2B vs. B2C
Some B2B business models and technologies in particular may be too complex for the average crowdfunding platform investor to comprehend, or feel totally comfortable with. On the other hand, most B2C businesses are not only easier to understand for the non-professional investor, but your company may benefit from the exposure to the wider audience you will be dealing with on an equity crowdfunding platform. This is especially true if you have a “social impact” element to your business.
Conversely, B2B companies may get added benefits from the ecosystem of B2B-oriented VC firms, including both potential strategic partners among their portfolio companies, as well as portfolio network contacts with actual enterprise customers.
The difference between VC funding and equity crowdfunding is quite stark in this area. Seeking funding from a VC firm really is a specialized form of a targeted sales campaign, with very little “marketing” involved, past making pitch decks and related materials clear and attractive. The key word above is “targeted”. You need to carefully research potential VC investors for industry, geography, and funding stage focus, to name a few important criteria. But it’s critical to also “network your way” into the VC firm’s attention, as opposed to the more straightforward method of contacting them directly. This is a bit mystifying, I know, to the uninitiated. I wrote more about that here.
Obtaining capital via equity crowdfunding, on the other hand, more closely resembles a broad-based online marketing campaign typical is selling a product, including PPC advertising, mobile marketing campaigns, direct e-mail approaches and other digital marketing methods.
Terms, Fees and Valuation
Terms – you set the terms, much like when selling any product online.
Valuation – you also set the valuation, platform investors will either “buy” or pass.
Fees – Equity Crowdfunding has platform fees in the 5-10% range, subtracted upfront from the amount of capital raised. In addition, as mentioned earlier you will incur digital marketing and other costs, which could be significant.
Terms – Term sheets come from the VC. At best this will be a negotiation, if you are lucky enough to have a “real” operating business and don’t “need” the money desperately, or you are able to generate competition among VC firms for the deal. Otherwise it’s mostly take it or leave it.
Valuation – Again, unless you have a strong negotiating position, the VCs usually drive the valuation to meet the metrics they require for an investment. More often than not, it’s likely to be lower than what you might get through equity crowdfunding.
Fees – VCs: no real fees per se, so everything raised can be used to build the business. The one caveat here is that VC funding is often in the form of a convertible note. The interest on the note can be viewed as an added cost of funding, therefore somewhat of a hidden “fee”. This doesn’t reduce the amount of upfront capital to invest in the business, however, and is often deferred until an exit event.
Desired investor characteristics
This is an area which will really drive your choice between VC funding and equity crowdfunding, if you indeed have such a choice. Are you looking for “hands off” capital with little or no ability to affect your company’s strategic direction and governance? Do you want to have total control over the terms and valuation of your deal? Equity Crowfunding is for you. The downside is there is no guarantee you will meet your fundraising goals with an equity crowdfunding campaign, even after incurring costs of the campaign. As mentioned earlier those costs can be significant and include expenses in the areas of legal, accounting, marketing and platform fees. In addition, there are significant disclosure requirements due to the “semi-public” nature of these platforms.
If on the other hand, you would value active advice from your investors, who may also have a strong network that you can leverage to accelerate your business? Like the idea of an investor partner that has the existing contacts and muscle to get your business some coverage in the news? VC funding is your ticket. One other downside to keep in mind is that because venture capitalists are looking for “home runs”, they sometimes pressure your management team to hire faster as well as take other steps to grow faster than is optimal for your particular company and market segment.
If you’re seeking specialized investors who are passionate about the Social Impact of businesses, there are a small number of VCs with this focus. However, the is a much larger number of social impact investors addressable via equity crowdfunding.
So that’s my primer on choosing between equity crowdfunding and traditional VC funding. It’s wasn’t intended to provide all of the answers you need to choose between these two funding strategies, but to provide some basics and get you thinking about the questions you should seek further information on.
Have you used either of these funding mechanisms to grow your software or hardware company? Fill us in with any hints or gotchas using the comment field below.
Follow Phil Morettini and Morettini on Management via Twitter, Facebook, LinkedIn, RSS, or the PJM Consulting Quarterly Newsletter. To ask a question or discuss a consulting or interim engagement, contact Phil directly at [email protected]
If you liked this post please share it with your colleagues using the “share” buttons below: