When raising money, think like a venture capital. For many entrepreneurs, success begins with a great idea. However, how do you get this idea off the ground? Raising money is needed for your company, but how do you attract investors?
Many young, emerging growth companies, understand that venture capital serves as an alternative. Often, venture capital provides cash funding in raising money, which is exchanged for shares in the business and an active role in the enterprise’s future.
In January the National Venture Capital Association, one of the trade associations representing the U.S. venture capital industry announced the results of its industry paper, MoneyTree Report, on venture funding for fiscal year 2012. The Association with PriceWaterhouseCoopers reported that venture capitalists invested about $26.5 billion in 3,698 deals last year. The report showed declines in both dollar and deal transactions down about 10% and 6%, respectively, from 2011. Fiscal year 2012 was the first drop off in venture capital activities in three years.
Economic uncertainty hindered the growth in new investments. As a result, many venture capital funds shrunk during the year. Venture capital firms have increased fund reserves to support funding of current investments and have become more discriminating in assessing new deals.
Understand that before a venture capitalist takes on higher risk the firm will determine the upside pay off. What this means is that the entrepreneur must do his or her homework to meet the expectations of the venture capital firm in raising money. This is a two-way street.
Venture capital funding comes with a price. Some of the considerations the venture capital firm will review in raising money when assessing a potential investment include:
Venture capitalist want to mitigate or manage their risk. Entrepreneurs, on the other hand, can assemble a strong management team, provide a well-written business plan, and show a leadership team that can execute the plan in raising money.
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But now wait! The Jobs Act of 2012 is a game changer. Small businesses and entrepreneurs will have increased access to crowd funding sources. The U.S. federal government will allow participants in crowd funding projects to received ownership stakes. The U.S. Securities and Exchange Commission is writing the prudential regulations (the rules) for equity participations in crowd financing activities. With the recent departure of SEC Chairwomen Mary Shapiro, the regulations have been delayed (Mandelbaum, 2012). The SEC is tasked to protect investors. Investing in small business, especially start-ups, are notoriously risking and fraudulent activity can take place.
What is Crowd Funding?
A collective effort by consumers that network and pool their moneys, usually through the Internet, crowd funding enables the investment in and support of efforts initiated by other people or organizations (Ordanini, Miceli, Pizzetti, & Parasuraman, 2011). Kickstarter and Indiegogo are leading intermediaries organized to support crowd funding. Kickstarter alone helped facilitate over U.S. $350 million in project financing pledges.
Founded in 2009 by Jeff Chen and Yencey Strickler, Kickstarter is a New York based Internet funding platform for creative projects surrounding the arts to include films, games, and music to art, design, and technology. Backed by Union Square Venture and other venture capital firms, Kickstarter’s revenue model includes receiving five percent of the funds successfully raised through its platform (Milian, 2012). Indiegogo, a San Francisco based crowd-funding site is another player in the crowd finance space. Pledges to projects can be funded in U.S. dollars, British pounds, euros, and Canadian dollars.
So how does this work?
Financial backers, which are armchair philanthropists of projects, put their trust in the project creators by providing cash in return for a promise of a future return. The return can be naming credits as with a film, a discount price of the develop item, or some insignificant benefit. With the Jobs Act, crowd funding in the U.S. is about to evolve. Providers of project funding will be able to receive equity participations. Entrepreneurs will have greater access to capital as new providers of crowd sourcing and investors see opportunities.
Examples of projects that successfully received funding in 2012 (Santos, 2012) include SmartThings, which raised over $1.2 million with the help of 5,694 backers. With an initial goal of raising $250,000, SmartThings designed a device to let users digitally monitor and control parts of their homes. As a digital hub, allows the use of apps to switch on and off appliances with a bevy of sensors and products. OUYA raised over $8.6 million from more than 63,000 supporters. The goal of the company was to initially raise only $1 million. The company’s project was a $99 Android-base gaming console that offers its own controller and promises to make game development affordable.
Lazar, S. (2012, December 27). Meet The 25-year Old Who Raised Over 8 million on Kickstarter . Retrieved May 7, 2012, from Huffington Post: http://www.huffingtonpost.com/shira-lazar/pebble-founder-eric-migicovsky_b_1497515.html
Mandelbaum, R. (2012, December 26). Crowdfunding’ Rules Are Unlikely to Meet Deadline. Retrieved January 3, 2013, from New York Times: www.nytimes.com/2012/12/27/business/smallbusiness/why-the-sec-is-likely-to-miss-its-deadline-to-write-crowdfunding-rules.html?pagewanted=all&_r=0
Milian, M. (2012, August 21). After Raising Money, Many Kickstarter Projects Fail to Deliver. Retrieved December 27, 2012, from Bloomberg: http://www.businessweek.com/news/2012-08-21/kickstarter-s-funded-projects-see-some-stumbles
Mulian, M. (2012, December 5). Crowd-Funding Site Indiegogo Is Going International. Retrieved December 27, 2012, from Bloomberg: http://go.bloomberg.com/tech-deals/2012-12-05-crowd-funding-site-indiegogo-going-international/
Ordanini, A., Miceli, L., Pizzetti, & Parasuraman, A. (2011). Crowd-funding: transforming customers into investors through innovative service platforms. Journal of Service Management , 22 (4), 443-470.
Santos, A. (2012, December 27). Insert Coin: 2012’s top 10 crowd-funded projects . Retrieved January 3, 2012, from Engadget: http://www.engadget.com/2012/12/27/insert-coin-2012-top-10-crowdfunding-projects/
TechCrunch. (2011, February 14). Startup Sherpa (Kickstarter): How To Get Successful Projects. Retrieved from YouTube: http://www.youtube.com/watch?v=kqDNWcu6Hs0