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Don’t Be Fooled By All the Hype For Crowd Funding

 

crowdfund

The new hot topic for entrepreneurs in the last couple of years is crowd funding, which is anticipated to at least supplement, if not replace, the slow and mysterious process of current angel and venture capital investors. The problem is that crowd funding means something different to everyone, and even I have been confused by the different ways the term gets used.

So I have set out here to outline and offer some practical advice on the many different models currently used with the term “crowd funding” and “crowd sourcing.” The newest equity model was passed into law in early 2012 via the JOBS Act, and, waiting for the rules to be defined by the SEC, still has no scheduled date for availability in the USA:

  • Startup equity crowd funding. This new model (now only legal in the UK) will allow large numbers of “regular” people to invest small amounts online to get an ownership position in early startups. This is not a get-rich-quick vehicle for consumers. As a current angel investor, I can attest that any investments in startups are more risky than the commodity markets, and you shouldn’t expect to see any return for many years.
  • Good-cause crowd funding. This model is a good thing, and has been around for years. Example sites include StartSomeGood and the Facebook Cause page. People can invest (donate) money to a project which has good moral/ethical value. No financial return should be anticipated, but contributors should enjoy the feeling of doing good.
  • Pre-order crowd funding. Here people make online pledges with their credit cards during a campaign, to pre-buy the product for later delivery – if it is ever built. Kickstarter is the big player in this space. It has had some notable successes for entrepreneurs (over $1M in funding), as well as non-starters. There is no concept of ROI other than product.
  • Rewards-based crowd funding. This is a variation on the two previous ones, where investors get the satisfaction of helping and immediately get a pre-determined reward or perk, such as a t-shirt or other recognition, but no equity or finished product. A good example site, and one of the earliest in this category, is IndieGoGo.
  • Debt-based crowd funding. In this model, sometimes called micro-financing or peer-to-peer (P2P) lending, you borrow money from a number of people online and pay them back after the project is finished. This has been popular in many countries for years via sites like LendingClub and Kiva. The allure is fat returns, but they come with a huge risk.
  • Ideas crowd sourcing. Technically, this model is not involved with funding at all, but “crowd sourcing” and “crowd funding” are often used interchangeably. Sites like IdeaBounty get your ideas off the shelf, and give you the wisdom of the crowds. Of course, this might also lead to investors, partners, and licensing opportunities.
  • Software crowd sourcing. This is basically the Open Source concept, where sites like IdeaScale facilitate the outsourcing of application development to the Internet community in the form of an open call. Sometimes contributors may get compensated later, but usually the rewards are just kudos and intellectual satisfaction.

Don’t confuse any of the models with other popular funding sites for startups, like FundingUniverse and Startups.co. These are primarily matchmaking sites between entrepreneurs and professional investors or banks. Often they do sponsor pitch contests with small cash prizes for funding, as well as other valuable services to support entrepreneurs.

It’s easy to see that whether you are an entrepreneur or potential investor, the Internet has opened several new options for the crowd to help you. These also open new concerns about lost intellectual property, Internet scams, and long-term return on investment. Crowd funding is exciting new territory, but I don’t see it replacing angel and venture capital investors any time soon.

Reprinted by permission.

Image credit: CC by Rocio Lara.

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About the author: Martin Zwilling

Martin is the CEO & Founder of Startup Professionals, Inc., a consultancy focused on assisting entrepreneurs with mentoring, business strategy and planning, and networking.

Martin for years has provided entrepreneurs with first-hand advice, mentoring and business plan assistance as a startup consultant. He has a unique combination of business and high-tech experience, and executive mentoring and connecting startups with potential investors, board members, and service providers.

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