Can the “Wisdom of Crowds” Work for Funding Startups?

Whether or not you believe that venture capital is broken, the necessity of funding startups still exists. One alternative to traditional funding models is “crowdfunding” – crowdsourcing the fundraising process.

Like crowdsourcing, crowdfunding is based on the idea of the “wisdom of crowds.” And crowdfunding contends that “the crowd” can be a better source for financial support than traditional funding avenues. As these traditional avenues are often criticized for being based on “who you know” as much as “what you do,” crowdfunding promises fundraising that is more transparent, more collaborative, more accessible, and more global.

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Disrupting the Relationship Between Investor and Entrepreneur

But as it is a different funding model, crowdfunding means a different sort of relationship between the investor and the entrepreneur. With many (but not all) crowdfunding sites, startups retain full ownership of their projects. Investors receive credit on the website, and sometimes a thank-you gift (a commemorative t-shirt, a free subscription or software copy, and the like). But there are no stock certificates, no seat on the Board of Directors, no equity.

While crowdfunding does provide entrepreneurs with needed funding, startups who raise money this way might miss out on some of other things that investors bring to the table, including business advice and connections. But arguably this is a vicious circle: In order to get that investor backing and to take advantage of investors’ connections, you often need pretty strong connections in the first place. According to John Rooney, CEO for the startup Jakaya, which is seeking funding for its collaboration tool via IndieGoGo, finding investors can be very challenging for those outside the tech world’s “inner circles.”

Crowdfunding, with Due Diligence

GrowVC is one crowdfunding site that aims to foster both the startup and the investor community. GrowVC is run on a subscription-based model, where subscribers make the decisions about what gets funded. Unlike some of the other crowdfunding services, GrowVC does due diligence on the companies that are listed there.

And this diligence is often pointed to as a flaw of the crowdfunding process. While a startup might be able to raise money using crowdfunding sites, these services do not necessite that these companies have a business plan or a viable product.

This is among the criticisms lobbed at what is perhaps crowdfunding’s most well known success story, the Diaspora Project. Although Diaspora was able to raise well over its initial $10,000 goal using the popular Kickstarter crowdfunding platform – it’s actually raised more than $200,000 – this is still no guarantee that Diaspora can build a viable alternative to Facebook. And while Diaspora certainly capitalized on the anti-Facebook sentiment, arguably its project would have not received such a positive response had it not been for the press coverage they’ve received. Several other alternatives to Facebook, for example – many of which actually have a product – also appear on crowdfunding sites, but have received neither the press nor the money that Diaspora has.

“Fund us if you believe in us,” says Jakaya’s John Rooney. And while “believing in a startup” is a prerequisite before any investor writes a check, crowdfunding does offer a chance for startups to expand that investor base outside the traditional investment circles. And as there can’t possibly be as many VC managers as there are good ideas, that’s not necessarily a bad thing.

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