Analysis

Will VCs stand out from the crowd?

Source: UK unquote | 09 Nov 2012
Crowd funding could compete with venture capital for deals

With crowd-funding service Kickstarter seeing its UK launch last week, entrepreneurs and venture capitalists may wish to consider the role of this new democratised form of financing in the investment landscape. John Bakie reports

The concept behind Kickstarter is simple. Post your business idea online, set a "pledge goal" and offer your products and bonus materials to people who provide cash to back your business. Kickstarter, which takes a 5% cut of the money pledged, has so far helped raise over $300m for projects as varied as music acts and video games to a statue of Robocop for the city of Detroit.

In return for donations, most projects are offering a special incentive. For example, if you donate $20 to a film project you might get a DVD, maybe for $30 it will be signed by the cast, or $100 gets you a package full of related merchandise. Kickstarter has demonstrated that users are willing to put big money to get exclusive content and play a role in a product's development from the beginning. One such example is videogame Project Eternity, which has raised almost $4m on Kickstarter, including five eager backers who put down $10,000 each to attend the official launch event and have a role in designing aspects of the game.

So what does this mean for venture capital investors? Well, for an entrepreneur who is protective of his equity, crowd-funding projects through services like Kickstarter could be a viable alternative to seeking seed finance from an institutional investor. Under the Kickstarter system, backers only receive items, not equity. This could be very attractive for a number of entrepreneurs who may feel they do not get good value when they sell equity to a VC.

For businesses that need a relatively small amount of start-up cash, the crowd-funding model has a number of advantages. Firstly, capital can be raised relatively quickly. The entrepreneurs can simply upload information about the project and set their deadline – usually a few months – and can then market their idea to generate interest and pledges. By contrast, approaching VCs, making a pitch and then negotiating the exact details of the deal can be a lengthy and complex process, particularly for the inexperienced.

However, crowd funding also has its drawbacks. Firstly, as the funders hold no equity, they have no long-term interest in the future of the business, and cannot or will not offer the kind of invaluable business guidance that can come from an experienced VC investor. Also, the Kickstarter model focuses very much on the immediate funding needs of a business. If, some months down the line, an entrepreneur finds they did not raise enough, or they wish to expand the scope of their development, they will not be able to return to their investors for additional funding, wheras a VC backer is far more able to provide funding or advice to capitalise on additional opportunities.

So, while Kickstarter's UK launch is likely to attract a number of entrepreneurs looking to develop their business idea through crowd funding, the VC community should continue to remind budding business people that this model has its weaknesses. While it might suit some business concepts, it simply cannot offer the same long-term backing, and crucial business experience that a professional venture capitalist brings to the table.

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