To understand the need for CrowdFunding we shall refer to a 2003 Bank System report labeled, the prospects of startups in the previous 22 year span, including all IPO’s dealing technology in North America. It was discovered that only 5% of those startups advanced to an IPO and only 5% of those IPO’s every created shareholder value later. It was also found that a similar trend existed in startups sold in mergers and acquisitions.

From these findings, we can discover several important items. Looking back to the circa 1980 economy, it was observed that lack of valuable startups symptomatically pointed to an weak Venture capital industry, mostly due to the lack of sustainable value in startup companies and not purely based on the high number of failed ventures. There has been much noise in the venture capital industry about the lack of an IPO window, but the 2003 study gives an answer as to why. IPO’s at present are not simply a viable form of venture capital liquidity, but also a dumping ground for low-value startups when sold partially to the public.

CroedFunding Financing

In reality, there are many secular and combined forces, disrupting and capable of further transformation of creating startups and the financial backing landscapes forever. These forces are feeding and giving rise to the newest form of crowdfunding, whilst also disrupting the old manner of things. These are deeply engrained and centralized areas with a small population, working with old-dated business models that exclude modern technology and social networking.

Yet it is important to mention, that while crowdfunding operates many current socio-economic trends, it does not present itself as a replacement for standard venture financing. Because of its transparent and decentralized mode of operation, crowdfunding reaches a wider audience than ever before and the edges of its changes defy definition, yet are oddly evident. For the first time in recorded history, the population of the world at large has the ability to take part in the financing (crowdfunding) of new ventures of all types and trades.  In looking at the scale of changes already incurred by this new realm of connection, one can only theorize at the enormity of the changes waiting farther into the years.

Emergence of Early CrowdFunding Financing

In recent years, funding mechanisms with an incubator style of operation have been increasing in number across the board. Popularized by companies like Y Combinator, which was founded in2005 by Paul Graham and others, several individuals and affinity groups have taken the thread of funding and creating small capital investment startups, in example, Y Combinator rarely makes an investment larger than $20,000.

At Stanford, SSE Labs is a startup accelerator created by students and modeled after Y Combinator, although it has no equity positions in its startups. Recent trends seem to prove that at least once a week, a new startup incubator is created. These incubators have been a very important answer to a shared problem set with the lack of real options for equity focused crowdfunding opportunities. These are, in a way, close relatives to crowdfunding, but is about to get much close. Firstly, we will discuss some of the problems with the incubator-style funding mechanisms moving forward.

The first of these issues is their narrow view within the gathered knowledge and wisdom of the crowd and is almost always constrained by geography and the multitude of incubators over that particular area.  In the recent past, the argument could be made that this would work in local areas as long as all of the right pieces lived in the same locality. But this is an era of cross-disciplines and geographic scattering. The necessary pieces of the puzzle are tossed to the wind, but it’s the outlier pieces need to complete powerful plans that are in complete obscure locations.

Creating a model that relies on a smaller and smaller cross-section of collected knowledge, is a pattern that the venture capital community has followed for the past half century. The power of the crowd is simply not just accessing the best ideas, but as will be discussed later with prediction markets, also about using the collective knowledge and experience as a sorting and leading indicator mechanism. This allows for scalability and that is what kills many early startups. Dividing and distributing the crowd by lines created by today’s incubators is not only unnatural, but also antithetical to using the full potential of the crowd.  Incubators and other seed-stage funding creations are absolutely required for the short-term, simply because nothing better has been created to replace them. Yet with the integration of crowd funding dynamics, it is a topic soon to be resolved.

When dealing with incubators, another issue one must be very aware of is that these seed only financers can be easily out maneuvered by downstream companies. Unless the market has been obvious about its demands, one can be tossed aside when needing to raise more capital. Getting original funding doesn’t guarantee further funding, provided that funding is deserved.  These points are voiced by George van Heogaerden of the Venture Company, who argues for a model that funds startups from start to completion, a monolithic funding strategy. A better model would be one that facilitates a rolling close and offer greater exposure to a larger crowd (such as Crowdfunding). This essentially offers better funding continuity because it ensures higher exposure continuity.

The name brand incubators understand this to the extent by naturally gaining more players, but could likely diffuse as the incubators increase their population. Barring major disaster, the crowdfunding model will launch the next mega companies.  The “open-sourcing” of deal contracts is one of the promising by-products of early phase funding from the past few years. Most assuredly, eliminating the inefficiencies of the innovation process will help create more innovation.  As well, with funding innovation moving to the logical direction of using a wider and better collected source of resources, i.e. crowdfunding, it allows a more direct mechanism for creating deal terms. This is key component for any large scale funding body to possess, and crowdfunding has it all.

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