Kickstarter for Startups
Is equity crowdfunding a viable alternative to traditional venture capital?
Hey there 👋🏽 It’s been a while, folks. Firstly, wanted to get you to up to speed on what’s happening on the personal front. The last few months have been stressful with health issues in the family followed by the second wave of Covid in India that hit us hard. I was actively involved in Covid relief efforts through indiacovidresources.in along with 250 other relentless volunteers. Things are now better on both fronts, and I’ll be giving the newsletter the most care and attention again. Thanks for the patience while I took a pause on the newsletter. With that out of the way, let’s dive into this week’s edition of The Discourse.
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Crowdfunding on the internet is not new. It has existed since 2007 through Kickstarter, GoFundMe, Indiegogo, and others. Through this type of traditional crowdfunding, product makers could validate demand and get initial funding to manufacture and distribute their products. Early adopters benefited because they got better deals for cool new products.
Equity crowdfunding is similar but different. Through equity crowdfunding, a company raises money from the public. But instead of a product, the funders get equity in the company. If the company turns out to be successful, the crowd-funders get a piece of the upside.
Perhaps most importantly, equity crowdfunding allows non-accredited investors to invest in early-stage startups. A privilege, previously restricted to only accredited investors.
The bar for accreditation is relatively high. The SEC defines an "accredited investor" as a person with a net worth of $1M in assets or more (excluding personal residences) or someone who has earned $200k in income for the previous two years. These categories include just 3% of the population in the US. And 89% of venture capitalists are men.
The world can benefit from more diverse investors.
Similarly, in India, an accredited investor has a liquid net worth of at least Rs.5 crore and total annual gross income of Rs. 50 lakh.
While governments put these measures in place to protect non-seasoned investors from losing money in high-risk investments, they also contribute to the rich getting richer. This leaves the 97% who don’t meet this bar to be left out of high-reward startup investments.
This is where equity crowdfunding comes in. First, Let's look at what kinds of companies benefit from crowdfunding.
Community, Clout, Creators
Equity crowdfunding works best when your customers have a strong belief in the company or founders. To understand this better, I asked Sahil Lavingia, founder of payments platform Gumroad, about his perspective in a fireside chat through On Deck. Gumroad raised $5M via equity crowdfunding in March 2021 (disclosure: I am an investor).
This belief can come about in three ways:
A company that is community-driven has unique advantages. Through interactions with the founders and founding team, customers and partners can gain an intimate sense of the company. They will know well the company listens to feedback, ships on time, and has a strong vision for the future. They are best positioned to know more of the prospects of the company than someone who is not part of the community. As a result, they will develop that sense of belief in the company.
"If you feel like you know your community and your community knows you, then it's a great fit. Clubhouse, Haus, Roam Research, On Deck would be a great fit for this." - Sahil
Trust is built through consistency over time. If the founder of a company has created an influential presence online through their work or words, they can leverage this social capital when required. The audience intrinsically trusts the founder, that when it comes to raising a round they are ready to jump in.
"Get to the point where your sales pitch is just a formality." - Sahil
If the company is a two-sided platform and one side are creators who use it to gain financial or social capital, it’s a good fit. Think Stripe, Clubhouse, Twitter, Instagram, YouTube — all these platforms have creators who leverage the platform to further their careers.
Let’s take Clubhouse as an example. As a creator, I know that if Clubhouse succeeds, I am likely to succeed along with it. The money raised by them can go towards strengthening the team, improving the product, or acquiring new customers. In that sense, I am placing a bet on the company. I stand to gain both as a creator and as an investor.
The incentives are aligned and there’s a sense of trust.
How does crowdfunding help the company?
As a customer, I will have many options of products or platforms to engage with. For e.g. if I want to participate in an audio conversation I might use Clubhouse or Twitter Spaces. If I am an art creator, I could sell my artwork on Gumroad, Stripe, Patreon, BuyMeACoffee or a similar platform.
What equity crowdfunding does is that it creates a lock-in.
In the example of the art creator, if I am also an investor in Gumroad, I would choose Gumroad over its competitors to sell my artwork. It becomes a no-brainer.
For a company, you couldn't ask for a better outcome. You’ve created another moat through crowdfunding.
Leverage your investor’s audience
“Capital is a commodity, especially in this market”. - Phin Barnes of First Round Capital in 2019.
When money is a commodity, an investor’s influence, audience, and connections become their true value add. To bring this into perspective, let’s take two hypotheticals:
You might have 5 investors with 100K followers on Twitter — an audience of 500K.
But if you have 1000 investors with an average of 10K followers — an audience of 10 million.
Evidently, the latter is a lot more attractive in terms of reach and thus initial interest in your venture.
What's in it for the investor?
While trying to answer this question, I took to Twitter to ask the question: Why did people invest in Gumroad's equity crowdfunding round? I got over 20 responses, including Daniel Vassalo himself (a Super Creator on Gumroad).
The sense I have got from others is that the ROI wasn't the primary driver of their investment decision. I would summarize their reasons as follows:
Belief in the founder
Burgeoning space (in this case the creator economy)
Being part of a mission
Already a customer or creator on the platform
The investment would improve the product
Bragging rights and FOMO
Openness - public product roadmap, Clubhouse sessions
Lastly, people cited ROI. Even though the financials have been disclosed, I doubt people spent a lot of time analyzing this investment rationally and technically. The ROI will be a cherry on top.
Future of equity crowdfunding
So, is equity crowdfunding going to overtake traditional VC investments any time soon? Not quite. For most startups, it still makes sense to go for traditional angel investment. The brand value of a Tier 1 investor like Andreesen Horowitz or Sequoia is a strong selection signal in the market.
The connections that VCs can bring in especially in Deep-tech and B2B businesses are valuable. However, there is a value to a mix.
Gumroad's equity crowdfunding round was paired with an investment from prominent SV investors Naval Ravikant (AngelList) and Jason Fried (Basecamp). You get the best of both worlds — signaling from top investors while still including your customers in the growth of the company.
Another example of this mix between VC and crowdfunding was Roam Research opening a crowdfunding round for early customers aka "Believers." They aimed to raise $50K through crowdfunding but ended up being oversubscribed 120x at $6M+, finally settling at $1M for the round.
A sign of things to come.
VC funding won't become obsolete yet, but for consumer and creator economy businesses, equity crowdfunding might have its day in the sun really soon.
Thanks to Halle Kaplan-Allen, David Burt, Elizabeth Mendes, Alfonso Guerrero-Villa from Foster for providing feedback on early drafts of this piece.
📘 Read of the week: The Great Online Game - Not Boring - Packy McCormick (19 min)
That's it for today, thanks for reading!
Did you invest in any equity crowdfunding campaign yet? Comment below to let me know and I'll reply to you. Give feedback and vote on the next topic here.
Talk to you soon!
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