Raising Capital From the Crowd

There are many examples of crowdsourcing of content and talent. In the recent past, crowdsourcing of capital has received a lot of attention and interest as well, despite its potential drawbacks.

When Matt Flannery and Jessica Jackley had the idea to start Kiva to seed entrepreneurs in the developing world and help support sustainable livelihoods, they did not expect the idea to resonate so well with thousands of individual donors. But resonate it did. Seeing Kiva’s success, Jackley started ProFounder, a more traditional venture that connects individual investors to entrepreneurs and helps them through the fundraising and company-formation process.

Another company that has showcased several creative ideas and helped entrepreneurs raise money to take these to fruition is KickStarter. Smaller companies like invested.in, GoFundMe, StartupAddict, iVenturers and IndieGoGo are others with a similar business model in slightly different verticals. Then of course we have the angel groups like AngelList and AngelSoft, which seek to connect individual investors with larger pools of funds to entrepreneurs. A related model is that of CapLinked.

For the entrepreneur, this has been a long time coming. Individuals with a great idea but not many credentials to their name no longer have to struggle to find their way to a VC firm to raise capital. These outlets provide a more democratic and decentralized way of raising money, where a good idea with potential trumps personal connections or alumni networks.

For larger investors, diversifying their assets over a much larger pool of startups helps mitigate the risk associated with early-stage companies. Marketplaces such as SecondMarket also provide liquidity for these investors if they want to quickly exit an investment that is garnering wider interest.

For the smaller investors, crowdsourcing provides a unique avenue to get in early on great companies with little up-front capital investment. For friends and family of entrepreneurs, these avenues provide a hassle-free way of showing support for the venture.

One of the key problems with a crowdsourced model of fundraising, however, is how to signal quality. In the traditional world of VC-driven fundraising, personal connections, networks, and academic or professional brands serve as signals of quality. Meeting face to face with the founding team has been a great way to get a sense about their involvement and dedication to the venture. In an interaction shorn of personal contact, these critical steps in due diligence are lacking.

Crowdsourced fundraising exchanges have replaced these signals with user-generated quality signals, much like reviews on Amazon. While one can imagine larger investors picking several top-ranked proposals based on these quality indicators and investing in them, it remains to be seen how much a smaller investor relies on these to put all their eggs into one of these baskets.

Nevertheless, the plethora of entrepreneurial activity in creation of such marketplaces shows that this is indeed a growing trend. The day will not be too far when American Idol-like competitions are aired, showcasing plucky entrepreneurs defending their projects passionately and closing rounds worth a few million dollars from hundreds of thousands of investors. Lead the way, TechStars!

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