Crowdfunding or venture capital: Which equity route is best for your business?
5 min read
20 August 2018
Founder of online accountancy firm Crunch, Darren Fell, explores the pros and cons of crowdfunding and venture capital.
Venture capital (VC) has long been the obvious answer for SMEs looking for a major investment. But as the march of alternative finance continues, can crowdfunding work for established companies as well as startups?
There’s much to be said for the ethos of crowdfunding. For those companies that thrive on referrals, being owned by an army of advocates can be great. Crowdfunding can also be a way of rewarding the people whose hard work and loyalty a business depends. It gives staff and customers a VIP rate and a stake in your success.
But this route can present a number of challenges. Firstly, significant marketing and communications outlay are involved in crowdfunding. Specialist expertise is also needed, such as working through a nominee.
Transparency is another issue. Potential investors need to know the inner workings of a business and its future opportunities to decide whether to invest. How do you open that up without giving too much away to competitors? It’s one of the reasons crowdfunding is easier for companies that have little history and less to lose.
World Business Angel Investment Forum chairman Baybars Altuntas reveals the crowdfunding rules that entrepreneurs should adhere to.
Then there are reputational risks. Not reaching the target amount can feel like a pretty public kind of failure. What’s more, some businesses have found that launching a crowdfunding campaign becomes an invitation for industry sniping.
Another pattern seems to be emerging as crowdfunding matures – campaigns can end up being an advertising piece for traditional investors. A few people invest, but then it gets cancelled when a big investor swoops in.
While may be an effective way of raising capital, it can leave people close to the business dissatisfied if clients and staff were keen to invest.
VC is a considerably less complex option when it comes to the long-term consequences of giving away equity – namely because it’s all going in one direction and unlike crowdfunding, there’s nothing to dissuade future investors. It also comes with the advantages of at least one experienced business mentor.
There’s a good reason VC has long been the natural choice for high-growth businesses past the startup stage. Yet that doesn’t mean that every investment is a happy experience. Finding individuals that understand the overall vision and fit the culture is vital. A deal that looks good on paper won’t work if the shareholders end up pulling a company in different directions.
A few years ago venture capital had a slightly negative reputation in some SME circles. There were those who insisted on ratchet agreements and strong protections. Thankfully this is less common today and a middle ground of funds has emerged that are genuinely concerned about long-term business success.
If one investor is going to be more valuable to a business than the mass of advocates crowdfunding can potentially offer, it has to be about more than money such as expertise and true partnership.
Finding an investor with big business experience can have particular value for a growing SME. Entrepreneurs with growing businesses can often find themselves in unchartered territory, feeling their way through to the next move. A mentor who recognises each growth stage and is able to see the next evolution ahead can be a real asset.
Can debt play a part in the investment mix?
Of course, investment choices don’t have to be all or nothing and money can be raised from more than one source.
Whichever equity route is chosen it’s worth considering whether to accompany this with debt finance, if the business can support it. A mix of debt lessens dilution and shows the strength of the business, in that a bank believes it can service the loan under all circumstances. Investors love this.
So the upshot? Crowdfunding is an amazing investment mechanism in these modern times and can be perfect for early-stage companies or fast-growing businesses as a top up to a big VC investment round.
If you’re lucky enough to find a truly engaged VC who may have been there and done it as an entrepreneur before then character fit and a shared vision are crucial.
Darren Fell is CEO and founder of Crunch.