Will Crowdfunding Overtake Venture Capital for Startups?
Wealthy families and individuals primarily used venture capital to hold shares in several different companies. It wasn’t until 1946, with the founding of the American Research and Development Corporation (ARDC) and J.H. Whitney & Company, that venture capital would be used as a form of private equity financing. Venture capital has allowed investment firms to fund emerging and promising start-ups in hopes of receiving a high return for their riskier investment that banks would otherwise turn away.
This style of financing has created a problem in the venture capital world, allowing for the rise of “vulture capitalism,” a type of venture capital in which investors scavenge companies in financial distress. Investors who partake in this style of venture capital will then use a tactic called asset stripping, in which they will pick apart said company and sell its assets for profit. This usually leads to the destruction of the company leaving many unemployed.
Crowdfunding is on the rise as a new way to invest in start-up companies. Rather than relying on a few investors, crowdfunding invites anyone interested in investing and supporting an upcoming company. There are 5 different types of crowdfunding, here’s how they work;
- Donation-based crowdfunding
Donation-based crowdfunding is one of the most popular forms of crowdfunding. This type of crowdfunding is simple; it requires simply asking for a small donation from a large number of people. It is usually used to fund personal needs or matters, such as medical expenses, financial hardships, or community projects.
- Reward-based crowdfunding
In reward-based crowdfunding, backers are asked to donate to a new start-up or organization with a product or service promise once the startup is fully funded and launched. In this system, donors can earn different types of rewards based on the amount donated.
- Equity crowdfunding
Also referred to as Regulation Crowdfunding, crowd-investing, or crowd equity. This type of crowdfunding is used by medium to small businesses that need larger amounts of capital to kickstart their company. In exchange for donations, donors receive a percentage of ownership in the company. These funding goals are usually larger, and minimums are in the thousands. However, it is a good way to gather funds without the worry of traditional loans.
- Debt Crowdfunding
This style of funding works by asking for donations which will be paid back at a later date. Businesses that need capital but prefer to pay them back rather than give out equity are primarily interested in this form of crowdfunding. Funds are usually used to pay back loans or other financial obligations. Donors are told exactly what the money is needed for and when they are to expect repayment.
- Real estate Crowdfunding
Real estate investors looking to put their money in the real estate business tend to lean more towards this type of crowdfunding. With crowdfunding, investors can contribute smaller amounts of money than what would normally be expected when collecting funds from a real estate company or individual. The amount of funds also depends on the amount of property the investor would like to own. Investors can also receive payouts each quarter.
Venture capital often relies on startups having to convince a few large investors into funding their company. While this provides the appropriate funds much faster, this money comes with strings attached. Businesses receiving funds from these investors usually have to meet a list of terms provided, leading to business owners losing the freedom of complete control over their company. Vulture capitalists also pose a risk to these companies as these tactics have picked apart many companies for a quick profit.
Crowdfunding provides a new solution to finding the appropriate funds for startups to kick start their companies. A compelling story can manifest thousands of backers hopeful in the idea presented. Funds may take longer to be procured, however, since business owners must rely on the public to provide funds little by little instead of receiving large funds from a single source. With crowdfunding, however, businesses can retain complete control over their companies, taking them in whatever direction they choose without limitations.
While most successful crowdfunding projects tend to be in the electronics, food tech, and software industry, artists have also found a unique way to gain traction in the world of crowdfunding through NFTs (Non-fungible tokens). These valuable one-of-a-kind digital art pieces or content can be used as rewards for backing new video game concepts, apps, or other creative projects. Donors can receive special characters, applications, or artwork NFTs in exchange for their backing.
Venture capitalism might be a thing of the past as startups begin turning their eye to the public to let their companies grow and receive support. With new ways to gather funds for new companies evolving, crowdfunding is becoming increasingly popular. Now anyone can present a new idea, company, or project and, with enough promising material, gain traction through the public. Funding companies this way also provides a more accurate measure as to which startups will be successful.