In 1957, retired Gen. Georges Doriot invested $70,000 in a start-up named Digital Equipment Corp. Well, that $70,000 turned into $355 million. And when others found out about that, they started investing, too, and the venture capital industry was formed.
But while thousands of entrepreneurs have raised billions of venture capital dollars since then, the vast majority of entrepreneurs have failed to raise venture capital.
There are two key reasons for this. First, most entrepreneurs don’t qualify for venture capital since they can’t scale fast enough, nor do they have the potential for a large enough exit. And second, there are too few venture capitalists versus the masses of entrepreneurs who need money.
Fortunately for entrepreneurs, a new type of funding recently emerged called “crowdfunding.” Crowdfunding turns the tables, because there are now more potential investors than entrepreneurs.
Crowdfunding is when a group of people collectively fund a cause. That cause could range from paying for medical bills or a wedding to filming a movie or starting or growing a business.
To an extent, crowdfunding has been around forever and is the basis for most nonprofit fundraisers.
But due to the recent advent of two Internet platforms, business crowdfunding, or using crowdfunding to fund a for-profit business venture, has started to take off.
The two Internet platforms are Kickstarter.com and RocketHub.com. Each allows entrepreneurs to raise crowdfunding for their for-profit ventures (nonprofit ventures can also use them).
In brief, these platforms allow entrepreneurs to post their funding requests. They also handle all the funding transactions. The process works as follows: Entrepreneurs start by creating a video and/or text about what their venture is all about. Then, they establish the amount of money they need to raise and over what time period. Next, they set rewards for the donors. For example, for a donation of $25, donors may get a company T-shirt. Or donors giving $100 or more may get a $50 gift certificate to use once the business is open. All of this information is posted on the entrepreneur’s page on the crowdfunding platform.
The final step is for the entrepreneur to tell the world about his or her crowdfunding request in order to get people to donate. This is where it gets interesting. Crowdfunding is taking off because spreading the word about yourself or your venture is so much easier today than it ever was before.
For example, by using tools like Facebook, Twitter, YouTube and e-mail, infused with entrepreneurial creativity (e.g., creating intriguing/viral videos about your business) entrepreneurs can quickly gain awareness and support from hundreds, thousands and even tens or hundreds of thousands of people.
For example, in early 2010, four New York University students started a social networking company called Diaspora. The students posted their crowdfunding request in April 2010 on Kickstarter.com and raised $200,642 from 6,479 people, most of whom they’ve never met.
Diaspora, with its $200,642 crowdfunding round, has raised the bar for crowdfunding. Formerly, most companies raised between $5,000 and $25,000 from this method. But the average amount raised should continue to increase as entrepreneurs hone their ability to tell the masses about their ventures.
Both Kickstarter.com and RocketHub.com are reward-based crowdfunding platforms, which means that donors receive rewards for giving, even if the value of the reward is less than the amount of their donation.
Debt-based crowdfunding platforms, also known as social lending, are also available via websites such as Prosper.com and LendingClub.com. On these sites, entrepreneurs can request business loans from individuals rather than banks.
And, finally, there is equity-based crowdfunding, whereby funders give money in return for equity. This type of crowdfunding has not yet taken off due to the complexities of equity transactions. However, several entrepreneurs are working on solutions to this problem, and I expect that soon such a platform will exist.
The Internet, e-mail and social networking sites have allowed most of us to build larger networks of friends and colleagues and to interact with them more easily and frequently. Crowdfunding allows us to leverage these tools and connections into funding for new and growing business ventures. It is a unique form of funding that is appropriate for most entrepreneurs and is relatively quick and easy to raise. As such, most entrepreneurs should start tapping this new funding source immediately.
David Lavinsky is president and co-founder of Growthink (www.growthink.com). Since 1999, Growthink has helped thousands of entrepreneurs and business owners develop business plans and raise numerous forms of financing, from bank loans to venture capital and private equity transactions. Lavinsky can be reached at [email protected].
