Gasellit Blog

You’re an entrepreneur, raising money for your start-up but you’ve hit the wall? Looking for angel round funding in the range of 50,000€ to 200,000€ is not easy if you don’t already have a working product along with some cash-flow and growing number of other requirements. And Venture Capitalist aren’t interested anymore. Some people even say the Venture Capital (VC) model is broken. That may not be exactly true. They just aren’t investing in your start-up. Or maybe in no start-ups at all.

The financial crisis has had a severe impact on the venture capital industry and the funds have largely stopped funding higher risk areas of innovation. Many venture capital companies have woken up into a reality where the VC model is just not working anymore (and some of them focus on other things, like maximizing the management fee).

According to research by Deloitte, funds are reducing their overall investment, supporting existing portfolio businesses and shifting investment focus to later-stage businesses that are either profitable or close to profitability.

“We’re seeing reduced investment levels as firms either invest smaller sums in very early-stage companies, or invest traditional sums in fewer and much later-stage companies. The middle ground has been largely vacated.”

On the other hand, there are new kids in the block who can potentially redefine the game. People like Paul Graham (Y Combinator) as well as Marc Andreessen and Ben Horowitz (Andreessen Horowitz Fund) are introducing new funding vehicles for certain kind of start-ups. The problem is, that is not enough, and they are quite local. What if your start-up is in Europe or in Asia?

Recognise yourself from the above? Don’t worry, raising money for a good start-up is still possible. It just may come in smaller amounts from more sources. It’s now called Crowdfunding. And it’s not only for start-ups, actually.

Crowdfunding in a Nutshell

Crowdfunding is an alternate approach to get investments for a start-up. It’s not actually a new idea as it has been developed over the last decade, mainly in the film and music industries. Unlike traditional models which rely on large contributions from one or two institutions, crowdfunding is based on raising small sums from many people. Instead of raising 300,000€ from three angels (100,000€ each), you collect 10,000€ from 30 private investors.

Crowdfunding isn’t going to replace venture capital, private equity, debt finance or stock-markets. In many ways it’s an evolution of “friends and family” and “angel” models, just operating with greater transparency and on a larger scale. It may even turn out to be an essential and complementary part of the financing tools needed to cultivate and grow new businesses.

But What’s the Actual Problem?

Number of traditional investors interested in start-ups who are looking for money in the range of 50,000€ to 500,000€, has decreased rapidly. It is also true that in today’s world more can be done with less money (“the old 5 Million euros is nowadays 500,000€). Investments in this category are high risk investments with potentially high return. But most of the companies will fail. That is only one reason why traditional investors are moving (and have already moved) away from this category. When alternate investment vehicles are invented to fill the gap, also the traditinal investors will benefit as they can this way have more companies in the funnel for additional investments.

Is Crowfunding The Solution for this?

A successfull crowdfunding solution has to solve many problems in order to be a feasible alternative for the start-ups and investors alike. There is an obvoius need for process simplification (de-mystification) and standardization concerning documents such as Term Sheet and Shareholders’ Agreement. An initiative in this field already introduces a Standardized Term Sheet acceptable by both entrepreneurs and investors. Trust and transparency are also probably some of the biggest issues. How do you create trust in the online world? How do you manage the communication with so many stakeholders? There will most likely be new innovative solutions for all of these challenges in the near future. The change is inevitable. Additionally, private investors can invest 5,000 € euros in ten start-ups, instead of putting 50,000€ to one single company, effectively decreasing their risk as well.

Case Trampoline Systems

Trampoline Systems, a London-based social analytics business, is already using crowdsourcing approach to finance its growth. Trampoline is raising £1 million from up to 100 investors with a minimum stake of £10,000. This is most likely the first time a technology business of Trampoline’s scale has used the crowdfunding approach. The effort has been quite successful as in the first two weeks they raised £330,000.

Not everyone can become a Trampoline investor. The Financial Services Authority (UK) puts some limits on what you can cannot do. For example, one has to be certified as high net worth individual or as a sophisticated investor (details are here).

What’s Next

I’m expecting to see things happening in this space within a year or two. There is no reason why this could not happen (despite possible obstacles set by authorities, for example). There are a few interesting additional aspects into this. For example, having so many people as investors may enable you to use them as advisors or contact makers.

So what do YOU think about this?