Why Crowdfunding Is the Best Way to Raise Capital

The biggest myth about crowdfunding is that crowdfunding investors get crumbs. The tasty dishes go to venture capital (VC) firms. And those startups that can’t get VC investors to scoop them up turn to crowdfunding.

Nothing could be further from the truth.

Scores of startups use crowdfunding because of its unique benefits. I sat down with two founders of a fast-growing online wine club last week in New York City. The club has already raised $45 million from reputable investors like Crosscut Ventures and Bessemer Venture Partners. And now it’s about to raise again… at a much higher valuation thanks to its 69% gross margins and 333% increase in revenue since it first began selling wine four years ago. So why did it choose crowdfunding to raise up to $15 million?

The founders noticed the tremendous success of BrewDog, an international brewery and pub chain. BrewDog raised tens of millions of dollars from crowdfunders in the U.K., Europe and the U.S. In the process, BrewDog converted many of its new and enthusiastic investors to customers. And it was able to source capital from thousands of its customers. It just made so much sense. BrewDog has a much bigger and more enthusiastic community as a result.

BrewDog isn’t the only terrific company that’s turned to crowdfunding as its first choice. In fact, we’ve recommended that our First Stage Investor members invest in several high-quality companies that have embraced the equity crowdfunding revolution. These startups, among other things, are developing the world’s first nonaddictive opioid, creating an Amazon for prescription medicine, beating Elon Musk at his own game, and bringing custom tailoring to stores like Banana Republic and J. Crew.

As good as the crowdfunding space is now (and it’s really good!), it has the potential to get even better. Many startup CEOs are still stuck in the Silicon Valley VC mindset. And they either have never heard of crowdfunding or have been misinformed and have no idea what crowdfunding’s advantages are.

Some startups, for example, have no idea they can raise $5 million, $10 million or more from crowdfunding. At the last pitchfest I attended, only one out of the nine startups that pitched had even heard of crowdfunding. And out of the dozens of entrepreneurs I talked to at the event, only a handful even knew there was a perfectly safe and legal way to raise money from everyday investors.

Actually, crowdfunding and VC investing are just two of seven options startups have to acquire capital. Here are the other five…

Bootstrapping describes startups that self-fund. As an investor, I like companies that don’t just get by, but grow on the cheap. It teaches them how to do more with less. This discipline comes in handy when they do get money down the road. If a company can grow on a tiny budget, chances are its growth will take off with a little more cash to fuel it.

Friends and family of founders are usually the first ones to invest in a startup. Amounts can vary from $50,000 to $200,000 or $300,000. I’m a bit suspicious when a startup can’t show me “F&F” money. But I try to keep an open mind. Because there can be legitimate reasons for that.

A founder whose company is very new, but making excellent progress, told me he would never raise F&F money because it was too fraught with potential messiness down the road. Another founder confessed to me that her family simply didn’t have the spare savings to invest, and she didn’t want to impose on them. I understand both reasons. F&F fundraising isn’t for everybody. But it remains the typical first raise.

Loans are nondilutive. That’s a big plus. Founders don’t have to give up a big piece of their equity. But the interest rate can be onerous. Especially for companies years away from making a profit. And startups usually don’t have the assets, or even receipts receivable, to put up as collateral.

Accelerators are similar to incubators that provide operational resources and guidance. They also invest in the startup for a portion of equity. For some startups, the terms are far from generous. But it can be a powerful competitive advantage. Especially for startups that graduate from prestigious accelerators like Y Combinator or Techstars. Such a feat confers immediate legitimacy and an easier path to a successful first raise.

Angel investors are able to write big checks starting at $25,000. Many come from the tech world and are successful entrepreneurs themselves. They usually give startups a lot of valuable help along with their money. You can look up dozens of them on AngelList.

These different funding methods aren’t mutually exclusive. Companies can have crowdfunders, angel investors and VC firms on their cap table. Companies can crowdfund either before or after raising money from VC investors. Founders have a lot more optionality than they probably realize.

But with the massive advantages of crowdfunding, I’m astounded that more companies aren’t taking advantage of it. A successful crowdfund allows startups to raise money without giving away too much equity. It helps to market their company and product. And it gives startups the chance to attract thousands of investors who will become customers.

VC firms can wine and dine superstar early-stage companies and offer them sizable checks. The process can be quite intoxicating… especially for young founders.

But for the vast majority of young startups, the time and effort required to attract VC funding simply isn’t worth it… especially when they have a perfectly good alternative like crowdfunding.

Not all startups successfully crowdfund. Founders need a compelling idea, an MVP (minimum viable product) and a clear path to making money. Because crowdfunders aren’t fools. They tend to stay away from mediocre companies. And they tend to flock to the outstanding companies.

That’s where my team at First Stage Investor comes in. We take a close look at the dozen or so really outstanding companies that are crowdfunding at any given time and pick the best ones based on our in-depth research.

Not one of the companies we’ve chosen has ever told us they’ve regretted the decision to crowdfund. And, as an investor, I can say the feeling is mutual. Many of the companies in our First Stage Investor portfolio have already doubled or tripled (or more) in value. Crowdfunding works. And that’s no myth.

Good investing,

Andy Gordon

Co-Founder, Early Investing