Crowdfunding is giving a whole generation of startup entrepreneurs a new way to fund their dreams. While that’s good for entrepreneurs, it means the investors whose business it is to profit off of fledgling startups will have to work harder to woo top-notch entrepreneurs.
As the popularity of crowdfunding grows, it’s going to it ever harder for investors like Alexis Ohanian to swoop in with a their magic bag of money and make demands of cash-starved entrepreneurs. Ohanian is a co-founder of social-networking service and news website Reddit as well as a partner at Y Combinator, a seed-stage accelerator.
Crowdfunding, which has been made popular by sites like Kickstarter and Indiegogo in the past five years, allows creators to launch campaigns to raise money online. It gives entrepreneurs another option to get access to cash and just as, importantly, market feedback without having to necessarily tap the investor set. In recent years, the growth of crowdfunding has been accelerating. By some estimates, crowdfunding platforms Kickstarter and Indiegogo are expected to generate a combined $4.35 billion by 2015.
“We have seen plenty of companies get started now because of crowdfunding,” said Ohanian, speaking in New York City last week at the BBC Future World-Changing Ideas Summit. “They can now go to investors and say, look, we don’t just have an idea. We have tested the market. We have a million dollars in revenue. Now, invest in us, but on much better terms.”
Ohanian mentioned the Pebble watch, which raised more than $10 million on Kickstarter in 2012. Five months later, the Pebble team went on to raise $15 million in venture capital from Charles River Ventures, a traditional VC house with more than two decades of traction.
Crowdfunding and startup investing, either in the venture capital or startup accelerator models, do not serve identical markets. VC investors will never be interested in funding indie art films, a major set on Kickstarter, for example. And crowdfunding has not raised anything remotely close to the record $1.2 billion VC funding round that ride hailing app Uber raised earlier this year.
But where crowdfunding and startup investing do overlap, crowdfunding is increasingly giving investors a run for their money. Crowdfunding is “competition” for the Y Combinator model, says Ohanian. A startup can raise money on a crowdfunding platform and bypass traditoinal funding altogether. A successful crowdfunding campaign can also give an entrepreneur leverage to negotiate better terms and conditions on any investment deals that may come after.
Giving entrepreneurs a leg up may make the Y Combinator team slightly less profitable, but Ohanian also said that as a whole, crowdfunding is a good thing for society. “There is still a huge inefficiency in capital when it comes to investing and something like crowdfunding, as competition makes our jobs as investors harder. But if I take off my ‘Y Combinator’ hat and put on my ‘human being’ hat, it is a net win for all of us.”