Most people are pretty confused about what crowdfunding is and is not. Here are the ten key concepts entrepreneurs and investors need to understand.
1. Product crowdfunding and equity crowdfunding are really different.
Most people still confuse them. Product crowdfunding is done on sites like Kickstarter and Indiegogo. It allows you to finance innovation directly, at the product level; contributors pre-purchase products or simply donate. Conversely, with equity crowdfunding investors take stock ownership in the company making the product, which is very different and quite a bit more complicated. Equity crowdfunding is not yet fully democratized for ordinary investors, but sites like AngelList and WeFunder allow larger (accredited) investors to do it.
2. One is regulated and one isn't.
Product crowdfunding is largely unregulated. Equity crowdfunding is still evolving and is now permissible only amongst accredited investors and for rounds contained entirely inside certain states. Although the JOBS Act of 2012 calls for equity crowdfunding by unaccredited investors, the SEC is still developing rules to implement it.
3. Product crowdfunding has some real advantages.
Product crowdfunding campaigns can help to access hidden, hard to find capital. It can provide built-in marketing buzz if the campaign tells a good story and leverages social media. It can also help with pre-market validation prior to launch, helping to reduce financial risks such as pursuing office space if interest isn't there.
4. Product crowdfunding is great for your competitors.
The single biggest risk is that your potential competitors can monitor the market interest and demographics. Public exposure for the project means your pricing, design and feature list in addition to your exact launch timing is there for competitors to evaluate and react to.
5. Product crowdfunding is great for niche consumer hardware.
Consumer-oriented products and gadgets that are relatively easy to understand work really well on these sites because these devices are inexpensive, straight-forward, and fun to shop for and share. For the same reasons, smaller budget and buzz-dependent projects targeting niche markets can also really benefit.
6. Product crowdfunding is not great for enterprise products.
Complex products that are hard to explain are not going to make for a very sexy campaign because no one on the site is going to understand or care. Nor are B2B/enterprise products going to be a great fit since their enterprise customers cannot be reached through crowdfunding platforms. And if your enterprise product is something customers need right this minute, or requires a long-term relationship and after-sales support, the pledge-and-wait model doesn't make much sense.
7. Equity crowdfunding ought to provide powerful social benefits.
It can lower the cost of capital for companies, which is good for our national innovation and competitiveness, bringing more liquidity and efficiency to our economy. By democratizing funding it helps the "little guy" compete better which leads to more freedom and individual empowerment. It is good for the environment and small towns--an entrepreneur can do productive work anywhere without needing a long commute into the city.
8. Equity crowdfunding is not a panacea.
The single biggest concern people have with equity crowdfunding is the increased potential for fraud. These deals are very hard to inspect, and when they get hot, runaway momentum can distract from substance. If novice investors pile in, their lack of understanding about risk can lead to failed expectations and a lot of anger. It is also not a great way for an entrepreneur to build an investor base. Micro-investors with a shallow level of commitment and little to no experience can hinder more than help, leading to management distraction. This messy investor pool can make the company less attractive to subsequent professional investors who will be needed to carry the company forward.
9. Equity crowdfunding is a good fit for new entrepreneurs, hyper-local businesses or fan-driven projects.
Equity crowdfunding can be a great way to get a capital-efficient small or local business off the ground. It can be a life-saver for entrepreneurs in regions where capital is hard to find, or for first-time entrepreneurs who can't raise from larger investors. It also makes sense for hyper-local community projects because it provides an efficient mechanism for people to unite and support a desired goal. And due to the public platform, it is well-suited for projects that need buzz, strong customer validation, or a broad, engaged fan base.
10. Equity crowdfunding is not a great choice if you can raise funds conventionally.
Experienced bankable entrepreneurs will find conventional raises have a lower "cost" of capital. First-time entrepreneurs who need value-added investors to mentor, advise, and help vet and harden their idea will want to stick it out and build a traditional investor base of angels with industry expertise and contacts to open doors.
This is cool new stuff. There will ultimately be a long-term role for both types of crowdfunding. Whether you are an entrepreneur or an investor, it is important to understand the tradeoffs and decide whether you can live with them.