How Crowd-Funding Is Changing Everything and What That Means for Your Startup
When FundersClub entered the scene in 2012, crowdfunding was still coming of age. Sites like Kickstarter and Indiegogo were gaining traction, but weren’t widely perceived as serious financing platforms. They also left a gap for a company to democratize startup investing online. That’s exactly what FundersClub Co-founders Alex Mittal and Boris Silver set out to do.
Since then, they have witnessed (and pioneered) the movement of brand new fundraising strategies. No longer must startups be limited to taking their roadshow to Sand Hill Road to convince VCs in person. Today, as a founder, it’s possible to kick off your raise on Kickstarter — repaying your backers with perks — raise equity capital on FundersClub, and then move on to a perfectly traditional Series A.
But having more choices can be bittersweet. Hashing out a coherent fundraising strategy for multiple audiences can be paralyzing. Each platform requires a different, finely-tuned approach. At the same time, there are rewards to be reaped: the ability to build and grow an enthusiastic fan-base, rally more support for your company, and get backing for ideas that would have been passed over otherwise.
In this exclusive interview, both Mittal and Silver, who have now backed over 80 companies with FundersClub, talk about what they have seen work, how startups can choose the best path for their business, the upsides and pitfalls of different crowd-funding options, and best practices for each.
CHOOSING THE RIGHT PLATFORM
“There are two main models for crowd-based financing today,” says Silver, now President of FundersClub. “There’s rewards-based crowd-funding — exemplified by Kickstarter and Indiegogo — where people give money to get rewards. A lot of product companies like Pebble, Oculus Rift, and Boosted have leveraged this. Then you have equity-based crowd-funding — the kind that FundersClub does, where investors invest capital; that’s been used by companies like Coinbase and Instacart. Both approaches can work, sometimes together.”
According to Silver, startups should decide which way to go based on their core objectives. Rewards-based crowdfunding can work well as a step towards de-risking customer demand and building a community of early adopters without giving up equity in the business. If you’re looking for savvy investors to provide feedback and connections that you can use to shape your trajectory, equity-based crowd-funding may be a good choice. They aren't mutually exclusive.
“Rewards-based sites can be helpful for startups if you want people to pre-order your product to confirm demand,” says Mittal, FundersClub’s CEO. “This is often the case for hardware-enabled businesses. When there’s a physical product, there’s something tangible you can offer users in return for their investment. I’ve seen companies pre-sell millions of dollars worth of units using this method.”
Oversubscribed campaigns on sites like Kickstarter or using tools like Tilt Open show that consumers are really feeling the problem or the painpoint you’re trying to solve, and that they are willing to pay for the solution, says Mittal. That’s one less unknown for founders and investors to be concerned about. Having solid evidence to point to can be remarkably influential when you talk to VCs and other investors. Still, there are some caveats.
Just because you’ve had a successful crowd-funding campaign does not mean that you will deliver a product that meets consumers’ expectations.
"There can be a disconnect in your ability to deliver to those expectations,” Mittal says. "In those cases, the tendency is for rewards-based backers to act more like unhappy consumers, a stress that can break a young startup. It is important to set expectations upfront and to remain in dialogue with customers."
Also, although fundraising seems to go hand-in-hand with starting a business, one should not engage in any form of fundraising just to go through the motions. The cost of starting a company, particularly for software businesses, has dropped tremendously. "It’s now very possible to bootstrap and avoid the time investment of fundraising until after initial demand has been validated," says Mittal. "That is actually the best time to fundraise, with early winds at your back, and we have learned that startups at this point are best able to leverage crowd-funding.”
Before newsmakers like Oculus got their start on rewards-based sites, many entrepreneurs were concerned that there’d be some stigma attached to this form of financing if and when they decided to approach VCs. Mittal and Silver agree this is no longer the attitude.
There are VCs that now expect you to have gone in the direction of crowd-funding first before approaching them.
"This isn't always appropriate, and it depends on your business," Mittal says, but crowd-funding tends to make sense in this context for hardware plays.
Equity-based crowd-funding — facilitated by companies like FundersClub — is likely the right choice if you’re hoping to source diverse capital in a round alongside traditional investors. Most companies that raise through equity-based crowd-funding do not do so at the exclusion of traditional venture. If you have all of the resources you need to approach offline investors already, raising through an equity-based platform could still be a good call.
“The advantage of equity crowd-funding with the right platform is that it can make the process of raising value-added capital more efficient for founders,” says Mittal. “When we founded the company, we did it with the goal of being respectful of founders’ time, allowing them to raise quickly but to still tap into a value-added network helpful for key tasks like hiring, forming partnerships, winning customers, and raising follow-on capital. It’s not just about the money or the transaction, these types of platforms can expand your professional network for growing your company.”
DISSECTING EQUITY-BASED CROWD-FUNDING
“In terms of audience, you get the benefit of a broad range of investors,” says Silver. “You are more likely to find people who are specialized and knowledgeable about particular industries and sectors. People are really interested in the companies they fund and how to help them succeed.”
If you’re making the rounds at established VC firms, the number of potential investors you are speaking with is likely much smaller. “Equity-based crowdfunding lets you go out to thousands and thousands of potential investors at once,” says Silver. “When you raise from a broad pool like this, you maximize your chances of really resonating with a subset of people.”
As he puts it, part of raising investment capital for your startup can be thought of as an exercise in finding the demand for investment in your company (and you should be mindful of who you accept investment from). The larger the universe of potential investors you expose your startup to, the faster and more likely it is that you’ll find that demand, if it exists. “Especially if you’re working on a non-obvious idea, like bitcoin was in 2012 when we funded Coinbase, this approach can lead to finding investors who are excited about your idea, understand your vision, and in a position to help you grow. Those are the people you want in your corner.”
Running a successful equity-based crowd-funding campaign can kickstart other sources of financing in the same way that raising money from traditional offline investors makes it easier to raise more funding. Silver says he has seen it again and again. “A company may have some investors waiting on the fence, and then suddenly they move quicker when they see the startup is successfully raising capital from other sources."
Almost every company we have backed to date has raised capital from traditional investors in the same round.
The other big advantage of raising on an equity-based funding platform is that all of that money is combined into one pool and treated as though it came from a single traditional VC firm on the cap table. There’s no confusion over who gets what or who has the power to influence the company going forward. Known rules and protocol applies, allowing founders to keep things simple and smooth. At least, that is the way some platforms operate. Always do your homework and know who you are working with.
While equity-based crowd-funding sites are designed to streamline the fundraising process, that doesn’t mean that entrepreneurs can approach them less seriously. Investors on these platforms still expect to see similar types of information that a VC firm would want in order to make informed decisions. For a founder, this means being able to clearly articulate key points about the startup and answer questions from prospective investors.
“Sometimes companies go to raise capital prematurely before they are ready to do so,” Silver says. “Another stumbling block can be poorly communicating the opportunity to prospective investors. It’s important to clearly outline what the startup does, how the product or service works, and other details that potential investors will want to understand.” If you’re not prepared to answer these questions, then you should ask whether you’re ready to raise any capital.
1) Know who you are working with. As a founder, you should do your homework on who you raise money from both online and offline. “Specifically with an online equity platform, look at the track record and reputation of the platform. Get a clear sense of what the process looks like. Talk to founders who they have worked with before. Understand how the platform can add value.”
2) Be Ready. “Your company has to be at an appropriate stage to do well on a site like FundersClub,” says Silver. “Because you’re raising capital online, traction and growth serve as important signals. Having strong customer testimonials helps, as does compiling any news or major press hits that you’ve landed."
3) Clarity is king. “You need to be crystal clear about what your product or service does and how it works. When an investor sees a lot of buzzwords being used, it becomes difficult to understand. That makes it hard to make an investment decision. It’s your job as an entrepreneur to clearly communicate your business and its value proposition in a way that investors can understand easily and quickly.”
“Ahead of raising capital, get feedback from people you trust — fellow founders, advisors, other investors — and see what questions come up the most often about your startup. Those will likely be the questions that other potential investors will have, and you want to have good, well thought out answers ahead of time. You may only have one shot to clearly communicate your message,” says Silver.
4) Cover the key points. “The information you post should be no different than what an offline investor would look for. Hit the main points: What is the idea? How does the product or service work? Who’s on the team? What key milestones have you hit? What are your metrics for success? What is the market size potential? What are the investment terms? How big is the round you’re trying to raise? Ideally, you have a pitch deck that works without you being there to explain it.”
“Rewards-based sites do an excellent job of helping companies pre-sell compelling products and rally an audience of early backers,” says Silver. “Now that there have been a number of success stories where companies have raised on Kickstarter or Indiegogo and gone on to raise significant amounts of venture funding in subsequent rounds and/or get acquired, it’s become generally accepted in the venture community.”
VCs are now looking to crowd-funding sites as sources of cutting-edge ideas.
“Success on reward-based sites really shows that people like the idea of your product,” says Mittal. Plus everything is more free and flexible. It’s easier and more likely for innovators and backers to communicate on these platforms, and there are less rules and restrictions around how someone can back a project (and what they should expect in return). Fewer rules boosts participation, and more participation can only be good for your case.
“When you pit equivalent businesses, one that does have this demonstration of interest against and one that doesn’t, it’s an easy win,” Mittal says. “Your company will be held a bit higher by VCs and other investors where credibility is concerned.”
At the same time, it’s important to remember that rewards-based sites are strongest at proving interest in an idea, not necessarily a finished product or company, he says. “A lot of evolution can happen before you ship something. So while it’s great for building community and getting all this attention, you really do have to understand and surmount that nuance.”
VCs will not always take a successful rewards-based campaign seriously. You can’t rest on your laurels and assume that the money will naturally flow your way. “You can’t get away with a campaign if the reality of your product isn’t close to the expectations you set up in your campaign,” says Mittal.
I could promise you the world for just 99 cents, but that doesn't mean I can deliver it.
“Investors on equity-based platforms are going to be much more discerning than the average backer on a rewards-based platforms — they will be geared to sniff out things and really understand what is being promised, the assumptions a team is making, and the barriers that stand between them and what they are telling people they will make possible on demand,” he says.
Mittal and Silver agree that the two biggest traps for rewards-based crowd-funders are poor planning and falling short of expectations upon delivery.
“Many entrepreneurs underestimate the amount of planning and groundwork it takes to pull off a rewards-based crowd-funding campaign,” says Silver. “It can also be very dangerous if a company raises money from product pre-sales and then runs out of cash before they can deliver rewards. Then they have to quickly raise money from somewhere else, and if they can’t do that... they’re in serious trouble of not delivering.”
Avoiding these mistakes is all about anticipating the unknown and being willing to shift course quickly if need be.
An incredible number of obstacles emerge when you try to bring an idea into the real world.
“You see this often with hardware manufacturing — these projects can take much longer to complete than people tend to expect,” says Silver. “As an entrepreneur, you need to be mindful of the expectations that you’re setting for your early backers. You need to have done your homework and the relevant research so you can make reasonable estimates about the timeline and try to anticipate where things could change. Communicate your plan the best you can, and if it changes, communicate that as clearly and quickly as possible.” Basically, don’t get stuck being dishonest because you’re worried about disappointing people. That will just make it worse.
“It’s surprising how many examples there are of companies that didn’t fully consider how they would deliver on what they were offering on rewards-based platforms,” says Mittal. “Whatever happens will directly impact your reputation, and as a young team, that’s a big deal. It doesn’t just matter now either, it will follow you into the future."
1) Set up a strong feedback loop. “The best way you can calibrate customer expectations throughout a rewards-based crowd-funding process is by continually talking to them, actively soliciting their feedback, and building it into your business as you go,” says Mittal. “You don’t want them to just love the idea and then hate what you end up making. You want to be able to point back to where you got ideas for changes, how you listened to the people who backed you, and why you did what you did. It will make it much easier for people to reconcile what they're getting with what they thought they’d get.”
2) Keep running your company. It’s not unusual for founders to pause what they’re doing to raise funding. They forget or simply don’t have the bandwidth to continue building, hiring, and developing at the pace they need to. The same can happen with crowd-funding campaigns, but entrepreneurs can’t afford to put things on hold when a large online audience is waiting for their reward. “You have to keep your eye on the things that matter: Are you getting the right team in place? Do you have the right operations and infrastructure to support what you’ll need to do? Do you have sustainable competitive advantage? All of these other factors will make or break your ability to take advantage of the money you’re raising,” Mittal says.
3) Expect customers to be customers. While you may think that you have some extra leeway with your backers on rewards-based crowd-funding sites because they are your “fans,” you probably don’t. “What we’ve observed is that people who do purchase into rewards-based campaigns act a lot like regular consumers. They expect to get a product at the end of the day,” says Mittal. “You can’t assume that they have the same mentality that you do as a founder, or even as an investor. They are regular people, people who will be disappointed by delays and changes and bugs. While some may be helpful, they can’t be expected to help you get through delays or solve problems.”
4) Set a price point. “Because rewards-based crowdfunding backers behave so much like normal customers, it’s vital that you hone in on a price point that both resonates with consumers and works for you,” says Mittal. A lot of people don’t put much thought into pricing on sites like Kickstarter and Indiegogo, but it can blow up into a huge issue if you aren’t transparent from the beginning. “If you’re aiming for sustainability, whatever price you come up with, it needs to cover all manufacturing, delivery, support, etc. Some people believe they can use these campaigns to get attention, sell a lot upfront, and then make up the difference with equity or VC funding, but I don’t support that thought process. It’s irresponsible and unsustainable.”
5) Do your recon. “If you’re going to go down the rewards-based crowd route, it can be very helpful to speak with other founders who have done it before,” says Silver. “They can tell you what to expect both on the cadence of communication with customers, as well as how to actually execute your plan. You can avoid the mistakes they made and capitalize on what went well for them.” Knowledge sharing with founders can make a big difference for you.
HERE TO STAY
Regardless of all the failed campaigns and crowd-funding hiccups in the news, it’s here to stay — and likely grow massively as a source of capital for startups.
“There’s a rapidly growing acceptance of it in the tech and business community, proven in part by the follow-on investments by traditional VCs in companies that have partaken in both rewards-based and equity-based crowd-funding,” says Mittal. “Of course there are people who still argue that it’s a mistake to expose information about what you’re doing to the broader world, but that’s increasingly not the era we’re living in. There is still a place for confidentiality of certain ideas and information, but exceptional execution is usually the driver of startup success today, not unique ideas.”
He predicts a day when all investors — including VCs that have been around for decades — will be online in one form or another. “We’re already seeing firms having more robust online presences, communities, and software tools for their companies, it’s just a matter of time before we see online transactions offered by traditional investors. Not all platforms will be the same, or accomplish or deliver the same value, but the online evolution of VC is already beginning and will keep going."
The real momentum behind the trend today is that crowd-funding leverages the power of digital networks to efficiently pool capital, Silver observes. And the more people who get involved, the more prevalent crowd-funding can become.
“You see the impact on both sides of the market. It not only allows more people to participate more easily as investors or as early product buyers, it also creates larger capital availability for novel products and services,” he says. “By helping the aggregation of capital and removing friction from the process, it brings new ideas to the market. Crowd-funding is a powerful trend that we should all expect to continue in a big way.”