Don't Abandon Crowdfunding -- Manage It

In the recent HBR article "The Crowdfunding Road to Hell," Daniel Isenberg argues persuasively that crowdfunding — specifically equity crowdfunding — cannot work. As an entrepreneur, angel investor, VC, philanthropist, and CEO with 40 years' experience, I cannot agree.

From my experience investing in emerging start-ups (I'm invested in 60 right now) and launching my share of both failures (4) and highly successful (3) companies, I can attest that Mr. Isenberg is perfectly correct in his assertion that it's dangerous to expect crowdfunding of equities to work the same way crowdfunded donations do. Furthermore, I understand all too keenly the complexities of determining a fair valuation for companies that are too early in their development to fit existing measurement standards and can't meet the criteria for standard bank or SBA funding. I also agree that due diligence is an imperative — and is often overlooked by crowdfunders as impractical or overly complex. And finally, I concur that a crowd mentality can frequently encourage those who invest to be stupid. Even so, I strongly maintain that crowdfunding is a valuable and critical element of the funding landscape that needs to be carefully considered — not rejected. It is no secret that over the past four years many, if not most, traditional sources of loans for early stage start-ups have largely dried up. Or that crowdfunding is starting to become a substantial source of much-needed capital.

Consider the data just released in this week's "Crowdfunding Industry Report" from www.crowdsourcing.org. The April 2012 report estimates that 452 crowdfunding platforms (CFPs) raised nearly $1.5 billion in 2011, and that funding volume is on track to nearly double to $2.8 billion in 2012. What's more, of the four crowdfunding segments the report tracks — crowdfunded equity, lending, rewards, and donations — equity-based crowdsourcing is growing the fastest, up 114% this year (primarily driven by European CFPs, since equity based crowdfunds in the U.S. will not be legalized until 2013). The kinds of start-ups that can most quickly and efficiently attract these funds (and garner the most money per campaign) are, the report goes on to specify, those that offer digital goods like software applications, games, films, and literature. More than 80% of campaigns in this category have raised more than $25,000. Sure, this amount pales in comparison to the $282 billion that U.S. banks lent (without real estate as collateral) to small businesses in 2011, according to the FDIC. But as Brad Kine, president of loan provider On Deck pointed out in an article by Helen Avery in the May 2012 issue of Euromoney, these businesses weren't really very small. The majority of these loans go to businesses with $3 million to $50 million in revenue, leaving the bulk of the nation's small businesses, which haven't yet reached that $3 million theshhold, cut off. Yet these are the very businesses — particularly the start-ups under five years old — that are among the most important sources of new job creation critical to our economic recovery.

What, then, are these business owners doing for funding? They've been relying on credit cards and home equity loans — funding vehicles that have been severely affected by the struggling economy. So if they can't get money in those ways, and the banks aren't going to help them, we need to recognize that crowdfunding, as it grows, will play an increasingly critical role in the entrepreneurial ecosystem — with or without the participation, wisdom, and safeguards of more-established investment vehicles. It's time that traditional investors stop casting stones at the crowdfunding industry and instead partner up to ameliorate and avoid the pitfalls Mr. Isenberg has so aptly described. This week's announcement of the CrowdFunding Professional Association (CfPA) is a positive start. Education is critical. Meaningful SEC guidelines are a must. While any investor — accredited or not — should avoid the temptation to rush headlong at crowdfunding, the concept fills a critical role. We should respect and celebrate this new mechanism. And we must learn to treat this new and growing phenomenon with care.