Why VCs should be looking out at equity crowdfunding

Equity crowdfunding platforms are working to democratize venture funding. VCs should be looking out at the breadcrumbs crowdfunded companies leave behind.

Key Takeaway

Crowdfunding platforms, from Crowdcube and SeedInvest to Indiegogo and Kickstarter, are seeing more underrepresented groups invest in companies and raise capital, in stark contrast to the statistics for which traditional VCs are coming under fire. Many turn to crowdfunding platforms for reasons beyond access to capital – from external validation to building brand ambassadors – and are leaving behind clues that can indicate their future success.

Crowdfunding is more gender- and race-neutral than traditional VC

Crowdfunding is being hailed as the answer to the gender and racial gap in VC funding. Looking at a study on the gender gap in the VC space from equity investment platform CrowdCube, online platforms like theirs are attracting more female investors by providing a safer space for women to become more actively involved in investments. 27% of registered investors at Crowdcube are women, while there are only 14.5% women in traditional angel networks. Additionally, less than 2%of the world’s capital is invested by women, and less than 11% of VCs are female.

The entrepreneurs that receive support from crowdfunding platforms also remain much more diverse than those that receive funding from traditional methods. The funding gap in the traditional VC space has been increasingly in the spotlight when it comes to both women and minorities. In 2017, all-women founding teams received just 2.2% of total venture capital investments, while all-male teams received 79%.

Yet, according to a study performed by First Round Capital within their portfolio base over the last 10 years, teams with at least one female founder perform 63% better than male-only founding teams.

Moreover, Boston Consulting Group and MassChallenge released a study proving that businesses funded by women ultimately deliver higher revenue. The female-founded startups observed in the study outperformed their male counterparts in terms of revenue, bringing in $730,000 over a five-year period versus $662,000.

Noting this pattern, equity crowdfunding platform Republic has made it their goal to support female and minority entrepreneurs on their platform. According to their latest report, “25% of investments on Republic have gone to companies with underrepresented founders of color and 44% have gone to companies with a female founder versus 1% and 13%, respectively, for the industry.”

Equity crowdfunding may be the answer entrepreneurs are looking for, and it’s causing a bit of a disruption in the industry.

It’s not all about the money

Entrepreneurs, however, are turning to crowdfunding for more than access to capital. While crowdfunding is of course a great way for startups to raise necessary funds, a recent study from NC State University found that in fact it was the number of donors a particular project attracted that was able to better predict its success rate, rather than the amount of capital raised.

Why? External data insights. Donors on crowdfunding platforms are notoriously open with their feedback, and it’s an easy way for an entrepreneur to either validate or invalidate their idea with potential users quickly. The funders tend to be early adopters who want to have an impact on the product they’re investing in. As well, they’ll be much more vocal ambassadors when they want to see a product succeed.

“There are two main sources of value that crowdfunding backers bring to tech entrepreneurs,” Michael Stanko, an associate professor of marketing in NC State’s Poole College of Management and lead author of a paper on the work says. “Respondents told us that the most valuable thing backers did was serve as evangelists, raising awareness of forthcoming products through social media and traditional word of mouth. Secondly, entrepreneurs told us that they also benefited from crowdfunding backers not being shy with their opinions.” They often offer insights that can significantly improve a product before it goes to market.

Ironically, entrepreneurs that far exceed their goals on crowdfunding platforms aren’t necessarily the most likely to succeed. The researchers found that this set tended to focus less on more radical innovation in the future.

What does this mean for traditional VCs?

It’s not a secret that VCs have been coming under fire for statistics that point toward favoring white males. Public sentiment toward equity crowdfunding platforms, alternatively, has remained definitively positive.

As well, the majority of businesses that receive VC funding are in big cities, and despite the billions of dollars invested each year, VCs are much more difficult to come by than it might seem.

Most importantly, according to Forbes, with equity crowdfunding “the success of an investment is no longer dictated by a successful IPO, merger or acquisition because the investor can sell their shares immediately if they so choose.” This upsets the traditional VC model, which relies on major exits to make a return.

What this has done is shift the place or the importance of a VC as the main gateway to funding. It’s also put pressure on them to rethink some of their potential exit strategies. As a result, more entrepreneurs have access to capital, competition is increased, and investors have new exposure to early startup investment opportunities.

Rather than viewing equity crowdfunding platforms simply as competition, VCs should be looking at them both as a potential pipeline for future deals and as a first line of validation/customer feedback for new potential companies. Combined with data from social conversations and news media around the companies, this can serve as a useful set of online breadcrumbs that can better inform their next deal.

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