Saturday, August 09, 2014

How the democratization of funding is changing the venture capital landscape

How the democratization of funding is changing the venture capital landscape
By Linda Bernardi 

Over the last decade the venture capital and funding market has changed dramatically. Whereas in the past venture capitalists were the go-to-guys in the playground, there are new players giving entrepreneurs with many choices. One used to focus their efforts in the famed VC offices on Sand Hill Road, but today it is happening in every corner and coffee shop around the world.

Here are nine of the new entrants into the funding game:

1. Corporations making equity investments in start-ups. These are generally strategic investments and can have potentially huge upsides. Often a precursor for an intended acquisition and could mean a large investment, but the corporation is not interested in leading the round. They are generally passive investors and not on boards.

2. Corporate venture funds. With billions of dollars in reserves, companies are very well equipped to make large venture investments. Most large companies have very large VC operations, i.e. Intel Venture Capital, which has billions of dollars invested in start-ups and larger companies, and runs as a lucrative venture firm. Other companies with major venture operations include Google, Samsung, and many others. This assures a seat at the table for the large corporations and close involvement in innovation.

3. Angels and angel consortiums. There are tens of thousands of individuals with high net worth around the globe, investing in start-ups. You can do so either individually or in a groups that collectively evaluate the opportunity (due diligence) and are able to invest extremely rapidly. The pot has gotten much richer and in the right consortiums you could see over $1 million raised in a week, or much larger sums. Angels are very strong in initial rounds, but quickly fizzle out in subsequent larger rounds (as the risk appetite and investment tolerance is limited), and that is when the VCs step in.

4. Super angels. These are individuals with extreme high net worths and an appetite for investment. These individuals can fund an entire round by themselves and this is becoming quite prevalent. Such investors can bet in the tens to hundreds of millions with very little politics and in record speed. This definitely is in the sweet spot of VCs as that is where they would be playing and threatens the VCs chance to play.

5. Equity investment funds pouring money into deals. These are equity companies who invest in companies and could be affiliated with large financial institutions or stand-alone firms.

6. Boutique VC firms. They are generally founded by a few highly successful entrepreneurs who have had some phenomenal exits. Unlike the traditional VCs these boutique VC firms are hot and sexy and the ‘in’ group!  They are super connected with the current pulse and are cool and highly sought after.

7. Accelerators and incubators: These started out as kind hosts to help start-ups become successful. In return they get a percentage of equity of this start-up. Over time, after a number of successful exits, the equity adds up into millions and hundreds of millions of dollars, and voila in comes this new player into the funding game. Often very dynamic entities, with great and current connections, who greatly drive and impact what the “next big thing” is. This is one of the places that VCs and the above entities go shopping to see what is hot and what to invest in. Hence, they have an interesting driver role in addition to being where very new start-up entrepreneurs want to be associated with.

8. Crowdfunding platforms: Thanks to Kickstarter and Indiegogo now everyone can invest in an idea or a company from around the globe in a matter of hours. You can put in from a few dollars to thousands and beyond. Equity is not shared with the investors, so the founders get to keep the money raised, to make greater headway faster. It can be at the pre-prototype stage or purely conceptual. It is about what the market will respond to so creating passion is key. Today via these platforms, a start-up or an idea, can raise millions from the general public while at the same time they are mass testing their idea on the spot.

9. Global money: The VC investment field used to be dominated by the United States, specifically Silicon Valley. Somewhat like Hollywood, the folks that believe they are magnificent and exceptional. Rightly so at times, as they made major bets which paid off, allowing us to have today’s amazing tech industry. However, large bets are being made in all continents and in places such as China, Russia, India, South America and every part of the world and the bets are massive. This game is no longer only dominated by Silicon Valley. In fact, the largest tech IPO we are expecting to see will be from China, Alibaba this August. This category is directly a threat to the current VC market.

As an angel investor in the United States and other countries, and an entrepreneur who has been on the fund-seeking side, I love today’s world. If you have talent and passion, you are no longer beholden to a few VC firms. The world is your oyster. The more passion you possess (the more viral you are), the more people (from all the groups above) you can pitch to, you can get your product huge upfront visibility (market awareness) and have many choices about how much and from whom you want your funding from. I call this the democratization of funding.

I believe this is disrupting the VC landscape dramatically, but in the long run in a very positive way. The democratization of funding is and will continue to create a healthy and vibrant ecosystem with many, instead of a few entitled players.

The most important element for an entrepreneur which no VC can solve upfront is ‘how will the market accept my product?’ and to do so quickly. Crowdfunding platforms have opened up the theater of possibilities to all from around the globe. Within days you can know if your idea has appeal. A healthy ecosystem is vital for the future success of innovation and enabling entrepreneurs around the world to succeed. Market validation upfront (at the seed investment stage) will directly help the entrepreneur correctly value their company, and the visibility will allow more players to participate. This disruption will evolve us from the closed door (only a few see what is going on) secret term sheet discussions, to a transparent and vibrant world discussing innovation and great ideas openly.

Of course, soon after the initial seed phase, start-ups need serious funding and that is when the VCs will get to play and compete with the large players.  This is a growing-up period for VCs to realize that they are not the only players, rather one of many. Among VCs there are those who bring massive experience and expertise to the start-up. These VCs will thrive.  However, those VCs who simply got to invest because they were the first to the table, or because the start-up was out of funds, will struggle.

This vibrant and healthy ecosystem of many players and the democratization of funding is core to this inevitable and fantastic transformation ahead. Most importantly, this democratization will bring much larger segments of the globe into the vital discussion of innovation. More ‘what-if’ discussions taking place, more possibilities explored and as a whole far better for the many instead of “just the selected few.”

Every person, from anywhere in the world, investing a dollar or looking at product ideas on the open crowdsourcing platform is a micro-funder in this new democratized funding ecosystem. Imagine the possibilities when many play in this game of innovation and the impact of this awareness on advancing our civilization.
In my next piece I will be discussing this notion of democratization of funding with key players in the various sectors discussed above, for us to get a healthy and dynamic exchange started. In this democratized world and dialog I hope you will be a participant. So looking forward to it!

While more players are emerging every day, one principle is understood and adhered to: the new ecosystem of funding is transparent and open to global participation, allowing for broader participation by both backers/funders (of which there are many types) and entrepreneurs/creators. This leveling of the playing field is the key cornerstone that makes the democratization of funding possible.

To take us further along our journey into this new and open world of funding, I interviewed the following individuals:

Yancey Strickler (chief executive) and Justin Kazmark (head of PR) at Kickstarter

Ryan Caldbeck and Rory Eakin (co-founders) at CircleUp

Dan Levitan (founder) at Maveron, who offered a venture capitalist’s perspective.

Dave McClure (chief executive) at 500Startups

I want to take you through some of the highlights of my conversations* with the people listed above. Next, we will connect the dots to see why this new world of funding is so necessary for the success of innovation globally.

1. Kickstarter:  How significant have crowdfunding platforms become?  In crowdfunding, we have the backers (the funders) and the creators (the entrepreneurs, idea-holders). Let’s also look as some numbers for Kickstarter for an idea of the massive playing field of backers, creators, and ideas/projects.

3 million backers pledged $500 million
214 countries and seven continents participated
975 people backed more than 100 projects each
19,911 projects were successfully funded
From day one about $1.25 billion has been raised on Kickstarter.

These are staggering numbers and growing globally by the day. If the rate of growth experienced over the last few years continues (and it is expected to go above and beyond this), these stats will blow your mind year by year! In other words, I want you to fully appreciate the scale we are talking about here; now multiply it into multiple Kickstarter-like platforms and expand globally for a full understanding of the impact of crowdfunding.

The financial model of Kickstarter is that it takes 5 percent of the overall amount raised if the target goal is reached and nothing else after. In other words, NO EQUITY.

Kickstarter has been a critical player in democratizing this funding ecosystem to include anyone and everyone from around the world. It is for this reason that I reached out to Justin and Yancey to get the full picture.  Here are my thoughts following our conversations:

Kickstarter is keen on creating an organic ecosystem which is focused on enabling any and all creative projects to be brought forward, get visibility and funding from backers. This is not because Kickstarter has a vested financial interest in the success of these companies, but because it wants the ideas to flourish. Ideas span wide-ranging arenas and have no limitations. In as such, Kickstarter is not focused on the consequence of the innovation or predicting the outcome. Rather, its goal is to make sure that ideas have a community to grow in, or in Yancey’s words, “the act of creating the environment and participating in ideas that can lead to amazing results, this evergreen arena that enables thousands of ideas of all kinds to succeed.” This brings a critical element of lack of bias, allowing the inclusion of any and all diverse projects.

The entrepreneur sets the raise limit (not Kickstarter) and once he or she achieves the goal, there is no upper limit. The amount of funds raised is a direct reflection the interest and trust of the backers in the idea.

First of all, I applaud Kickstarter for creating a culture that despite its huge success has not changed its operating principle. This culture was present and consistent throughout all my discussions with them. Secondly, Kickstarter is open to all backers globally and boasts creators in the United States, UK, Canada, Australia, New Zealand, and the Netherlands (the aspiration is to be open to all creators globally one day). It allows full and unobstructed participation, through which we can see what ideas are of interest to the masses. 

This is truly a democratic ecosystem, allowing funders of $1 or $1 million to participate. My main concern with this model is the need to cultivate an environment that not only allows all projects to succeed, but to ensure the creators “deliver” on their promise to their backers.  Stay tuned for an extended piece about a day in the life at Kickstarter this fall.

2. CircleUp:  As active angel investors, one of the major problems we face is missing the ability to see all the high potential start-ups. In addition, many of the companies are outside our areas of expertise. What if there was a specialized crowdfunding platform connecting funders with a specific sector (such as consumer and retail companies)? This kind of platform could solve the many mysteries of evaluating the start-up and provide the necessary funding infrastructure, term sheets and market potential. The result would be a highly effective ecosystem connecting the right investors with the right start-ups in the right way. Voila. That is exactly what CircleUp is all about. 

(Disclosure: Since learning about CircleUp I have signed up as an investor on the platform (investors do need to be accredited investors in order to participate).  Based on my conversations with Ryan and Rory, here are some of the reasons that I found CircleUp to be a critical player:

The co-founders have a background in consumer products and retail. They deeply understand the specifics of investing in consumer products and retail companies.

The VCs who funded CircleUp know this business well.

The platform is comprehensive in a delightful way, and addresses the large amount of critical (but often difficult to obtain and evaluate) information accurately for the investor to make informed investment decisions.

Companies and start-ups on this platform go through a rigorous vetting process, which is a key component.  They consequently have access to thousands of investors on a platform. Contrast this with the traditionally infinite, exhausting, and sometimes futile pitch sessions that start-ups go through.

Investors have access to many companies to invest in and can also participate in cohorts and groups called Circles, to collaborate closely together. I would say this is an almost addictive resource for investors, as in an hour you can not only view, but also carefully evaluate tens of companies accurately.

CircleUp gets a percentage fee based on a completed raise. Note: If the minimum is not raised, investors get their money back and no fees are charged.

For me, beyond the elements above, the key is that CircleUp stays in the picture after your investment, which is critical. CircleUp addresses many of the problems facing investors. This is a win-win for all the participants in this ecosystem, enabled by creating a specialized crowdfunding platform. The future acquirers of new products now can see what is hot and what is coming, and use the power of the platform to make acquisition decisions. I am hoping that such specialized platforms for many other sectors will emerge in the near future. In my assessment, some of the challenges faced by CircleUp include getting a strong pipeline of deal flows; attracting more entrepreneurs to the platform; attracting more investors to not just sign up but also participate actively in deals; and raising larger rounds. Also, as a strong advocate of global crowdfunding platforms, I hope to see CircleUp expand and accept start-ups beyond North America.

3. A VC’s perspective:  The earliest venture capital firm in CircleUp was Maveron. Managing partner Dan Levitan explained to me his views regarding CircleUp and crowdfunding:

“One, we invest in people first. We felt Ryan and Rory were categorically advantaged to create the leader in this consumer space,” Levitan told me. “Two, we believe that there is an untapped market for early-mid-range consumer products companies who are not getting the right visibility from the VCs and private equity investors. Three, we believe that investing in a basket of these curated early-stage consumer companies can create compelling financial returns.”

The discussion of crowdfunding and VCs is a much deeper (and wonderfully debatable) discussion. Without a doubt, being a part of the crowdfunding ecosystem gives the participating VCs a first-hand opportunity to engage with those start-ups that they would normally not engage with, as well as access market reaction and acceptance of products. A great way to see if the idea sticks!

4. 500Startups:  In 2010, Dave McClure founded 500Startups with the goal of starting an accelerator program plus a venture fund. Today 500Startups houses and incubates many start-ups with operations in Silicon Valley, San Francisco, Brazil, Asia, and other locations. International expansion is a key part of 500Startups’ growth strategy and I view this to be a unique feature of the company. Currently, 500Startups is raising its third fund at $100 million, which will clearly give them the substantial means with which to engage and invest in start-ups around the world.

So, why do I find 500Startups a critical player in the democratized funding ecosystem?
They continue to stay engaged with the startups beyond the initial educational courses and graduation, realizing that start-ups need a huge amount of help in many areas.

At an acceptance rate of 3 percent, there is a strong chance that the startups at 500Startups have a real chance of success. This creates a very strong ecosystem.

The culture that Dave encourages – open and real – resonates with the company as a whole, and I suspect it is a draw for similar-minded start-ups looking for the right accelerator space, as well as initial and long-term funding.

The portfolio is multidisciplinary and Dave is pushing for international expansion (which is critically important yet rare). We will discuss the international issues and obstacles in investing in another article in 2014, but suffice it to say, it is key for us to go beyond the Silicon Valley mind-set!

The 500Startup community is one of passionate, strong, and open-minded people trying to do the impossible.

Only about 30 percent of the companies advance to get larger funding, and from there many fall off which leads to a very small handful of winners. As 500Startups makes their revenue from equity plus a small one-time educational fee, equity is the payback. You have to make enough bets and have enough winners to make up for all the other investments you made.

With the rapidly decreasing cost of start-ups, (as compared to when I had my start-ups and needed millions of dollars to secure hardware, software, licenses, maintenance, system admins, etc.), today all of it can be secured instantly via cloud and app providers at a significantly lower cost. You don’t need more than $50,000 to get going. Seed money generally moves you forward and then a smaller first round can position you very well. Of course, when you are ready for your greater-than-$10 million, you will need the VCs.

This means that entities such as 500Startups are now the critical hub of identifying, educating, incubating, and nurturing the high potential start-ups. They are the platform for showcasing the next generation of great companies that VCs can invest in. Of course, as 500Startup is also a venture fund, the question remains, who gets to play in the hottest start-ups looking for larger funding in subsequent rounds? Without a doubt, entities such as 500Startups are disrupting the old investment model and are shaping what the future ecosystem will look like. In parallel, they are creating viable nurturing grounds to enable thousands of start-ups globally, who would have not otherwise survived, to thrive. One downside, however: there is only one Dave, and while his staff of 30 are super busy and fantastic, the question arises whether Dave can be there for everyone, everywhere at all times. This is a bandwidth issue and can be mitigated by having a very strong culture and consistent practices throughout the company.

There will continue to be many players in the new democratized ecosystem of global funding. I am thrilled to see the barriers being removed each day. This is key to increasing the rate of innovation globally by enabling new ideas and projects to get started and developed. I love that there is no longer a playbook and great ideas of all kinds are thriving.

Not only is there great transparency in today’s democratized ecosystem, but more importantly, we can test ideas and projects rapidly and break global barriers of funding. Only then, will we dramatically increase the rate of meaningful innovation.

*I’d like to thank these individuals with whom I spoke. All of them were open, accessible, and genuine – great to brainstorm with. As for the few high profile venture capitalists who were not willing to discuss this topic and engage in the conversation, note that this disruption is here to stay and I hope to catch up with you for the next go-around.

While I spoke with one player in each category, there are others with whom I did not connect. Each category has many critical players. For example, in crowdfunding: Indiegogo; in specialized crowdfunding platforms: RealtyMogul; in the accelerator category: YCombinator, TechStars, and others.

Linda Bernardi is a technologist, entrepreneur, author, investor and public speaker focused on transforming global companies. She wrote Provoke, which discusses why disruption is necessary for global innovation. She previously founded and served as CEO of ConnecTerra.

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