Startup entrepreneurs have more options in raising funds thanks to crowdfunding, an innovative way of fundraising from a large number of investors online. Since the JOBS Act this new investment phenomenon has grown in popularity as a veritable tool for funding startups.
At different stages of a startup’s development, angels and venture capitalists, or VCs, have been the major sources of funding but now crowdfunding is fast gaining traction in the corporate finance arena.
In recent times, these three groups have been experiencing a boom in their investment activities. VC investments for the first quarter of 2014 increased by over 57 percent, the highest since it reached its peak in 2001, according to a MoneyTree report by PwC. Likewise, angel investment round size has increased from $950,000 in the first quarter of 2013 to $1.2 million in the firt quarter of 2014, according to a report by SeedInvest. The crowdfunding market has also been expanding, with funds raised from online platforms estimated to reach $10 billion in 2014 from about $5 billion in 2013.
The availability of capital for entrepreneurs is not the issue anymore, but rather how to access these funds from the angels, VCs or the crowd.
It is important for entrepreneurs to understand the investment behavior of each funding source in terms of their industry preferences, at what stage they invest, the time and costs involved to close a deal, the added-value each side presents, and the degree of control in the business, among other factors, in order to know who best suits your funding needs at any stage of your business.
Here is a quick insight into investment behavior for the three funding sources.
Angels make investments worth billions of dollars each year in startups (investing $20 billion in about 60,000 startups yearly), and those in the tech industries experienced the largest deal flow accounting for over 37 percent of total deals in 2014, according to the SeedInvest report.
Similarly, VC investment in “Internet-specific” companies (categorized as Internet related businesses without consideration for the industries they belong) stood at $7.1 billion in 2013, the highest since the dot-com crash.
This reveals that both angels and VCs show greater preference for the tech guys when investing ahead of other startup entrepreneurs in sectors like real estate.
The situation is however different with crowdfunding as the presence of both general platforms (that serve many sectors) and niche platforms (whose investment activities are industry-specific) across the nation makes funding accessible to a wider spectrum of entrepreneurs.
Stages investments are made
Angels typically invest in a business at the startup and early stage of its development, therefore making them suitable for entrepreneurs at the early stages of their businesses that require capital to develop their ideas into products or projects.
VCs on the other hand typically invest at the expansion stage of a business, although they sometimes invest at the early stage (but rarely participate in seed stage investing).
Equity crowdfunding – the investment model of crowdfunding – also provide capital for businesses at their startup and early stages. Average investment via equity crowdfunding platforms are typically below a million dollar.
Degree of control in the business
Whether you use angels, VCs or equity crowdfunding, they all give capital in exchange for equity in a business. However, they all differ in the amount of stake they are willing to accept for their investment in a business.
VCs traditionally demand the highest amount of equity (ahead of angels and crowdfund investors), asking for as much as 60 to 70 percent of the business. They could make more demand on the business such as becoming a part of the board of directors. Angels on the other hand are more willing to part with their capital for a lesser stake in the business.
In contrast, because equity is greatly diluted under crowdfunding (due to the large number of investors), entrepreneurs have greater control over their business by adopting this method.
Aside the capital they provide, it’s also important to consider the added-value each side brings along to the business. Since the success of a business enterprise also depends on other inputs apart from capital, knowing the added value each group has to offer should be added to your consideration.
VCs provide the highest added-value to a startup. By bringing them on board, an entrepreneur will benefit from her expert advisory services (as a result of their wealth of experience in the industry), well-established network and commitment to the business for the long term. Angels, on the other hand, typically do not provide extra services apart from the capital they bring in.
When raising funds through crowdfunding, however, you have a large number of people with different experiences and expertise backing your business. You also get to have a big crowd as part of your support or collaborative network and could be your source of future consumers or clients as well. While this option provides a lot of options, entrepreneurs do run the risk of having too many cooks in the kitchen.
The choice of a funding source depends on several interdependent factors. . The key is to know those significant factors that come into play and be able to match them with the right group to approach and the appropriate timing and strategy to implement.