Entrepreneurs with business ideas typically beg and borrow money from family and friends to launch their companies.
But thanks to the Internet, they can now approach strangers around the globe with the chance to invest in their latest venture through websites such as Kickstarter, Indiegogo, StartEngine, RocketHub and GoFundMe.
The new format — raising money from hundreds of small donations instead of pitching ideas to venture capitalists who invest large sums of money — raises questions about which route to business success works best and which has the most staying power.
How it works
Business owners are able to use the Internet to raise money from a network of sources, friends, family, social media contacts. It’s an increasingly popular method as Millennials are drawn to the web-based solution for funding businesses.
Anyone can create a crowdfunding appeal — businesses, artists, nonprofits, authors, musicians, people who need money for college, mission trips or medical bills. From any location, investors can log on to the websites and donate to the cause or project of their choice.
According to Goldman Sachs and Forbes, crowdfunding increased from $880 million in 2011 to $10 billion in 2014. Marketing and public relations firm MASSolutions estimated crowdfunding topped $34 billion in 2015.
At the initial stages of raising seed money, entrepreneurs most often obtain funds from people close to them. However, “very often, those early investments have an infant mortality rate that’s high,” said Colorado Springs venture capitalist Bill Miller.
After immediate family and friends are tapped out, a business owner can ask strangers to invest in the project through crowdfunding.
But it does come with a price.
Crowdfunding sites charge fees in the 8 percent range, including the payment processing fee. Listing a cause is free; fees are taken from the money raised.
“Crowdfunding has changed the landscape … it allows the crowd to participate,” said Rita Crompton, co-organizer of the Colorado Crowdfunding Meetup.
Crompton helps inventors navigate intellectual property issues, licensing, manufacturing, presales and funding.
Using venture capital, business owners “end up giving so much of the business away. A lot of times, they get squeezed out,” Crompton said, adding that venture capitalists often invest in companies and then quickly turn around and sell their stake at a greater profit.
“Venture capitalists want an exit strategy. They want to sell it in three to five years,” she said. “The people we work with don’t want to be unemployed in three to five years. People now have control of their destiny.”
Rita’s husband, attorney Ray Burrasca, launched Colorado Crowdfunding four years ago. He has more than 40 years’ experience in law and business finance.
“There’s a whole new world out there when it comes to raising capital,” he said.
“Venture capital is diminishing and crowdfunding is increasing,” Burrasca said, quoting Mike O’Donnell, executive director of Colorado Lending Source. “He is acknowledging crowdfunding is emerging in a very, very large way. What we’re facing is a true revolution in terms of finance and, in particular, the significance of crowdfunding as a viable option to traditional finance. Crowdfunding is the new gold rush.”
Venture capital is startup money that investors and organizations give in exchange for equity in the business. While investors sometimes choose new startups, they usually want to see if the business can succeed without assistance before they invest.
Because they reach the businesses at different stages, both venture capital and crowdfunding should work well together, said Miller, co-owner of PV Capital, a $6.5 million venture capital fund.
Using crowdfunding, entrepreneurs raise cash at a very early stage; venture capital is typically traded for equity once the company is established.
“Venture capitalists are looking for companies that will get really big … companies that will get to $1 billion in market cap and hundreds of millions in sales,” Miller said. “They’re looking for the next Google or Facebook.”
“If the company doesn’t raise enough money and needs more, it’s often difficult to go back to those websites and get more,” Miller said of the “one-and-done” method common with crowdfunding. “With venture investors, as long as they continue to see the potential with that company, they will often be there to add additional capital to get it over the top.”
Venture capitalists will also bring their network of professional business contacts and other investors to help the new or expanding business, he said.
“For the right company, venture capital is probably a much surer way to get a company to a successful point. They’re very different models and suitable for different companies in the marketplace,” Miller said.
The business community places too much value on venture capital, Burrasca said.
“The truth is, we [Colorado] represent only 2.5 percent of the total venture capital investment in capital nationally,” he said. “Why do we pay so much attention to venture capital when it plays such a small part in business in Colorado?”
Puppy mill survivor
Lil Olive wants to tell her story.
And the Italian greyhound will get the chance, as soon as independent filmmaker Pete Schuermann raises $85,000 on the Indiegogo crowdfunding site. The money will augment his $400,000 budget to produce a documentary about puppy mills.
A greyhound with a droopy tongue who was rescued after more than 12 years at a Missouri puppy mill, Lil Olive went viral with her Facebook page fight against puppy mills, thanks to her owner Pam Horton.
The crowdfunding for Lil Olive is Schuermann’s second trip to the Internet funding platform. His last film, “The Creep Behind the Camera,” raised more than $80,000 at Indiegogo.
“It helps with our budget and it also shows [that] a lot of people are interested in our project,” he said. “Not too many investment pools will invest in films. It’s a high-risk, high-return investment.”
While the Internet can help, crowdfunding still requires marketing.
“The myth is that you post it out there — and the whole world sees it and starts throwing money at you,” he said. “It’s possible, but you can buy a lottery ticket too …”