With the advent and popularity of crowdfunding platforms, including Kickstarter and Indiegogo, as a winning alternative for funding your new venture, I find that many aspiring entrepreneurs are confused about the need to ever seek a professional angel investor.
I think it's great to have more options, but I still see each one having a place, so don't be too quick to limit your alternatives.
To refresh your memory, angel investors are typically high-net-worth individuals accredited by the SEC and willing to invest their own money in a high-potential startup for a share of the ownership. See the popular TV show Shark Tank for a glamorized version of how they work and what to expect in negotiation. In the real world, most angels are regular business people like you and me.
Crowdfunding, on the other hand, opens the investment door online to almost anyone who is willing to bet on a new product or service with an investment, typically for a chance to be first in line for the offering, and willing to forgo any equity or management position in the company.
In my role as a small-business consultant and mentor to many entrepreneurs, I recommend the following key considerations for the best strategy to pursue for outside funding, if you choose not to fund the business yourself:
1. Consider that consumer products and trends need market validation
If your new startup is addressing a consumer need, such as a new gadget or food service, then crowdfunding response can give you the ultimate validation of a large-scale market, as well as full funding.
Alternatively, with minimal response from the crowd, you may need to rethink your business plan.
For example, many of you remember the Pebble Smartwatch, which raised over $20 million and made crowdfunding real. Yet overall more than two-thirds of crowdfunding campaigns do not meet their monetary goal and have to return anything they do collect.
2. Know that business-to-business products need professional investors
If your target customer is a business, rather than a consumer, I recommend you skip crowdfunding. This is the realm of the angel investor, who wants to own a piece of the new business, and probably knows how to run it and wants a seat on the board.
For B2B startups, every investor expects to see a proven business model, with a working prototype and preferably a real customer or two. They don't get excited by early-stage research, development, or marketing hype. Crowdfunding is not the best platform here.
3. Consider the need for multiple rounds of funding
Most startups need more money than they anticipated, to grow and expand their business, after development and rollout.
Professional investors understand this need, and are prepared to support it, unless crowdfunding was the first round. Investors are very wary of unknown owners and valuation.
Facebook, for example, may seem like a reasonably simple consumer application. Yet it required 14 rounds of investment, totaling many millions, before it became profitable enough to fund its own growth and reach a current market valuation of over $500 billion.
4. Compare the time frames and costs of alternatives
In most cases, a crowdfunding campaign can be rolled out more quickly, and earlier in the development cycle, than a campaign to find professional investors.
On the other hand, crowdfunding platform fees cost more than finding investors, as much as 5 to 10 percent of the money you need.
5. Know that early visibility can be a curse or a blessing
For very competitive environments and disruptive products, you may want to limit your visibility before a high-profile rollout. You can do this by targeting specific investors, with nondisclosure agreements, but crowdfunding will require early and broad public marketing efforts of your time frame.
On the other hand, early marketing may increase your brand's acceptance, and the crowdfunding platform may be the low-cost way to spread the word. If your campaign is funded quickly and generously, this also sends a very positive message to customers.
In reality, the most successful funding decision I still see is bootstrapping, or self-funding. Even today, the majority of successful businesses are bootstrapped or funded in the initial stages by the founders or bank loans rather than outside cash injections.
The smart entrepreneurs I see evaluate all the alternatives, and pick the one that makes the most business sense for them.