Could Crowdfunding Reshape Entrepreneurship?

Anyone can be a venture capitalist. At least that’s a common take on new SEC regulations removing the “accredited investor” requirement for taking equity shares in private companies. More than a dozen crowdfunding sites are scrambling to connect would-be VCs with startups seeking capital, according to the New York Times.

The change may democratize finance, but there are no guarantees of that. The Times article points out that “the most promising companies—the high-growth ventures delivering the monster returns that keep the entire venture-capital industry afloat—may also be the ones least likely to bother raising money in small dribs from the crowd.”

Equity stakes are certainly not the only flavor of crowdfunding. There is charity crowdfunding and debt sites to crowdfund personal or business loans. Perhaps the best known sites reward backers who fund a band’s roadtrip, a feature film, or an inventor’s latest brainchild; those include Indiegogo and Kickstarter.

The most feverish buzz around crowdfunding promises it will re-invent the arts, alleviate poverty, and create a global meritocracy that supports innovation anywhere and everywhere. In the introduction to a crowdfunding-focused special issue of the California Management Review, Lee Fleming of the University of California Berkeley and Olav Sorenson, the Frederick Frank '54 and Mary C. Tanner Professor of Management at Yale SOM, note, “Crowdfunding remains an emerging and evolving phenomenon, one not particularly well understood by the general public and in some ways not even by those participating in it.” The space is evolving too quickly for anyone to pinpoint the best strategies to employ.

Yale Insights talked with Olav Sorenson about crowdfunding’s big splash and its long-term potential. In theory, it could be fundamentally transformative, as Sorenson says: “The entrepreneur anywhere can, potentially, get access to customers and access to capital.” But is it going to fulfill that potential? “I don’t think it’s a fad,” he said. “I do think there’s a question of whether it will live up to the amount of enthusiasm people have for it.”

One area where he sees tremendous promise is the chicken and egg problem of gauging markets. “The cool thing about sites like Kickstarter is that you can put a product out there before you’ve actually made it,” Sorenson says. The public response to a crowdfunding campaign can help an entrepreneur measure the level of interest and even the right price point. “That takes a lot of the risk, particularly the market risk, out of new ventures.”

There is no doubt that crowdfunding can have a dramatic effect for individual companies and products. Indiegogo has delivered over $900 million to more than 650,000 campaigns in 223 countries. Kickstarter has raised over $2.4 billion for over 107,000 campaigns. Most successful Kickstarter campaigns raise under $10,000, but there are exceptions. An inventor in Oregon raised over $13 million to make a cooler with waterproof speakers and a USB port plus an attached blender for mixing drinks. While a first pitch didn’t reach a $125,000 goal, some tweaks and a second try, six months later, made it the second most successful Kickstarter campaign, to date, behind the $20 million raised for the Pebble smart watch.

In all, crowdfunding raised $6 billion last year, but it’s still a niche. Sorenson said crowdfunding accounts for about 1% to 1.5% of the capital in a given market type. However, the rate of growth, over 100% annually in some segments, is attention-worthy. “If we project out a few years, it could easily become a pretty important piece of some of these areas.” Sorenson will be watching to see where it plateaus. “Is this something that will be 2% to 5% of entrepreneurial finance or will it be 50%?”

Even if it’s on the higher end of the range, crowdfunding may not be the best option for all types of ventures. “It seems like things that are consumer facing are easier to do through a crowdfunding campaign than things that might have a business as a primary customer,” Sorenson says. That means some elements of venture and angel funding will probably never be replaced. But for some startups capital could come directly from customers. “If you look at the really successful Kickstarter campaigns, they have thousands of people who are pre-purchasing the product and helping get the company going,” Sorenson says. “Those aren’t professional investors, those are people who are interested in something new.”