This new way to fund companies, recently coined as crowdfunding, is coming to a theater near you very soon. Here are five things that those of you who don’t live in the startup world need to know about this important new tool for raising investment dollars.
1) If you don’t know what it is, you will. Trust me. It’s going to be big. Hundreds of crowdfunding platforms are already popping up all over, some with a geographic focus, some with an industry focus and some with no focus at all. Facebook FB +0.36% and some of the other popular social networking sites already have expressed interest in allowing their members to raise money for their companies using their individual social accounts. And, all of this is before the telemarketers and email spammers have figured out how to harness this potential.
2) This ain’t your grandma’s Kickstarter. Perks-based crowdfunding sites like Kickstarter and Indiegogo have been around for years, helping artists fund their projects, allowing makers to finance their prototypes and enabling inventors to experiment. But what will be different this time is the ability to trade an equity stake (or a percentage of ownership) in exchange for an investment. Imagine the possibilities – you could own a percent of an actual company for, potentially, just a few hundred dollars. It’s a pretty cool opportunity when you really think about it.
3) You might lose your shirt. The MOST IMPORTANT thing the public must understand about crowdfunding is that it is very risky, and you could, very easily, lose your entire investment. Remember, this is an investment in a company that could just as easily (and more likely) go belly up than it is to become the next Facebook or Instagram. We know that more than 90 percent of startup companies fail, so the risks of investing in unproven, early-stage businesses could leave many investors disappointed or even angry. I think a good old gambling analogy is relevant here – the odds are stacked against you, but there is the chance you could hit it big. As long as potential crowdfunders understand this (and no. 4 below), then the onus to make smart investment decisions should be squarely on the shoulders of the person making the investment.
4) Don’t worry, there will be fraud. It is inevitable. People are going to game the system and take advantage of well-meaning investors in startup companies. No matter how many rules and regulations the Feds put in place, some level of fraud is going to happen. Americans should just prepare for it, and journalists should fire up their laptops.
5) Watch for more Instagrams and (unfortunately) more Pets.com.Increasing the ability for startups to raise capital from the crowd should increase the amount of capital available for entrepreneurs. And while this, in turn, could lead to more money flowing to more high-growth, job-creating startups (e.g., Instagram, Google GOOG +0.86%), it will, without a doubt, lead to more startup disasters (Pets.com). Sometimes raising money can be toxic to the culture, mission and team dynamics of an aspiring startup, particularly if too much money is infused into the business at the wrong time. But, I would argue that more startup activity (even failure) is a net gain for the economy. We should all collectively hope for many more super successful Instagrams than total disasters like Pets.com, but the numbers of both outcomes will more than likely increase due to crowdfunding.
If you’d like to learn more about this topic, I highly recommend theWeFunder FAQ section. Also, keep an eye on the Securities and Exchange Commission as its rules, when they are eventually issued, will make huge waves in the startup community. Finally, you can tune in to this presentationby Slava Rubin, who will tell you how you can raise a million bucks in 30 days or less. It is interesting to hear his thoughts on the current state of crowdfunding and his view of what the future holds for this new funding mechanism. You also can watch a video “primer” on the basics of crowdfunding told from the perspective of another crowdfunding site founder and entrepreneurs here.
(For more insights from Slava Rubin, watch this video from Kauffman’s Top of Mind video series of his conversation with Kauffman Vice President of Entrepreneurship, Thom Ruhe.)