Crowd-funding for startups. Is it a good idea?

Crowd-funding is certainly gaining popularity in certain markets. However, for crowd-funding to work well for all parties, it is important that the entrepreneurial eco-system in that market is mature and has investors & entrepreneurs who have seen some cycles of ups and downs. 

Here’s why:

Funding startups carries the highest level of risk. The percentage of startups that become successful AND are able to provide a exit and good return to an investor are very low. Hence, unless the ‘crowd’ comprises of folks who understand the underlying risks (or unless the investor group managers educate the investors well in advance), there is likely to be too much friction due to mismatch of expectations of returns on individual deals.  

Inexperienced investors who invest because they have ‘heard’ or read in media of sky high valuations for some startups, often are not aware of the risk ratio in investing in startups. They may often not be aware that investors most likely lose money in 6-7 of the 10 companies they invest in. May be one or two out of 10 companies may return the money invested, may be with some modest returns. And, probably one of the 10 may provide a decent return to make up for the losses but also provide the surplus to deliver a decent return on the total capital invested. Given this kind of stacking of successes and failures, over a 4-5 period most investors, if lucky, are not likely to make signinficantly more money than they would have on their overall portfolio of investments (stock markets, commodities, real-estate, etc.). A far cry from the ‘solid valuations and handsome & quick returns’ in startups they read about in the media. (What one sees in media are exceptions and one cannot plan life assuming exceptions to work in your favour… and certainly not consistently). 

Now, in many cases, when inexperienced investors are expecting breakout results, and are instead faced with losing capital in a company, they may start getting anxious and therefore pose challenges of investor expectation management for the founders of the startup. They could get interfering and imposing their views. These are real challenges, and certainly an unwanted distraction. 

However, that does not mean that crowd-funding per se is not a good option. It just means that you need to take care of a few basics before you accept ‘crowd-funding’:

• Make sure that the investors in your startup understand the underlying risks. If you are accepting money for individual investors (friends & family included), be sure that you draft clear and understandable agreements. Make sure that you explain to them the risks associated. (Do explain to them that they should not invest in startups unless they have an appetite to invest in at least 10  deals over a 12 – 18 month period. AND that they should invest only as much as they are willing & able to lose without losing sleep.)
• Be clear and honest about the plans, milestones and plan B in case the original pans do not work out as planned (they usually don’t). Giving investors the confidence that you are in control even when things are not going right is often comforting for them. 
• Keep them posted of all developments – monthly reports and quarterly calls with all investors are good. Inform them about bad news before they ask. Provide them a view of what you plan to do to address the issues. Be transparent. Be direct. 
• Define clear processes for communication between investors & entrepreneurs. Define how and through whom the interaction will be routed. A good option is to agree that one or two members from the investor group represent the group on the board or act as the ONLY communication & interaction point. Individual investors should route their queries or suggestions only through this/these designate individual(s). Only during the quarterly calls should all individual investors be invited to participate in direct interactions with the team. Even then, individual suggestions should not be binding and it should be made clear to the suggestion giving investor that the suggestion will be considered by the management and discussed with the board before taking a decision. This should be the standard procedure.

Hope you have a great experience in crowd funding your startup. Do let me know about your experiences, and any additional suggestions and learnings that you may want to share.