In the last few blog posts, I have written about how crowdfunding can be used to jumpstart both social ventures and cultural projects – but there is another potential avenue for crowdfunding, which may perhaps be the most intriguing for many people, and that is crowdfunding for investment in startups.
In the current crowdfunding model, projects are funded on a donation-only basis – in other words, it is not really an investment in the typical sense where you are buying a part of the future of the company, like you would with an equity investment in the stock market.
But a crowdfunding model based on equity investment (crowdfunding-investment) may not be too far off in the future depending on what country you are in; the creation of a crowdfunding platform for this type of investment already exists in a certain form in some countries (ex. the UK) and is being discussed in others (ex. the US). This is because the crowdfunding-investment model depends on federal security regulations; therefore, each individual country has to amend its own securities laws to legalize crowdfunding-investment.
During my time here in Sao Paulo, I wanted to test the waters and talk to a few startup companies with young founders in order to see what they thought of the crowdfunding-investment model. Here in Brazil, the options for funding a startup company are very similar to what they would be in Canada, although there is less depth for each option. Those options are: the government, angel investors, and the three Fs (friends, family and fools).
From what I have been told, it is next to impossible to get a loan from the government for a startup, so that option is basically void. The angel investment community (an angel investor is typically an accredited investor who makes early-stage investments in startup companies) is becoming quite active in investing in startups, although it is relatively new in Brazil in comparison to other countries. And then of course there are the three Fs, which like anywhere depends on who they are for each person and how much money they have.
Collectively, these options are sufficient enough for many companies to get off the ground – but they also leave a lot to be desired. Both the angel model and the FFF model have built-in limitations for startup companies. With angel investors, like any other professional investor, there is a level of dependency on the opinion of the investor(s) who is willing to make the investment – if he/she likes your idea, you get funded, if not, sorry. With the FFF model, the problem is that, in most cases, there is a level of sophistication and support that is missing – the majority of FFF investors may not have any idea as to whether the idea is viable or not, and therefore are unable to provide guidance, support or get other people involved.
During my discussion with a couple of new Brazilian startups, we chatted about these limitations and I threw out the idea of the crowdfunding-investment model just to see what they thought. In principle, they liked it. The idea of having a channel to move directly to the market without any intermediary (angel investors), while simultaneously maintaining the ability to involve the FFF in a much more proactive way, is very intriguing. So here is how it would work:
– Startups would put their idea up on a crowdfunding platform in the same way projects are posted up today
– Anyone with an interest in the company would be able to create an account, login to the platform, and make a specified investment in the company
– That investment would constitute a certain equity-based percentage of the company and would be tradeable and redeemable for cash at some point in the future (if the company is successful)
Of course there are numerous legal, logistical and competitive issues that would need to be addressed before this type of model could be launched, but in principle it is really that simple.
The crowdfunding model is much more engaging for the average project funder, as many people will not only invest, but also tell their friends, buy the product and receive various social benefits. In the future, those social benefits could be financial as well …
What are the benefits of this type of investment model for startups?
– Speed – startup’s can raise money and move to market much more efficiently than with the current model
– Independence – no startup is dependent on the opinion of an investor to launch their idea
– Engagement – the process of crowdfunding creates a much higher level of engagement for everyone involved
– Connections – people who make a crowdfunding-investment have a deeper connection to the startup and are more likely to talk about the idea through their networks
– Market Validation – having the ‘crowd’ behind an idea offers a form of market validation and proves that the concept is at least worth exploring
There is a lot of interest here in Brazil about helping entrepeneurs get access to capital, which is why I had some fun throwing the idea out there just to see what people think. My hunch is that the crowdfunding-investment model will be launched in every country around the world at some point in the future, but when that will be is anyone’s guess.
Overall, despite the multitude of challenges that this investment model presents, it would be a lot of fun to be able to sit down at a computer and make investments in startup companies that you really care about. What do you think, do you like the concept of being able to crowdfund startup companies?
It rains A LOT in the summer in Sao Paulo 🙂