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The Future of Start-up Financing — AngelList or Kickstarter?

What does start-up financing look like when it is unbundled (broken apart and combined in new ways with lower barriers to entry/costs/etc.)?

NOTE: this is kind of a rambling post to get some of the thinking down.  I’ll sharpen the ideas a bit.

Here’s the deal.  The good news is that venture financing can’t get any worse than it was, when it was bundled.  It is the pits.  So, what is going to replace it?  There are two contenders and they are approaching the problem from different directions.

Why am I looking into this?  If business financing is democratized in the right way, it’s going to make it MUCH easier to build business from home, roll out the direct economy, and achieve the American Dream.

Open-VC Financing

The first is an approach that looks very similar to the old model.  It’s a light weight venture capital.  The leading example of this model AngelList.  AngelList looks a lot like traditional venture financing, but its more open to participation.  

What’s forcing it to change?  The unbundling of work/business opportunity means the forming companies is less expensive/easier than ever.  Naturally, this has led to an explosion of companies looking for funding at smaller amounts.  Since traditional, slow moving, venture investors and angels couldn’t keep up with the deal flow or the number of small deals, a more open approach was developed.  

AngelList simply connects experienced investors looking for financing and companies looking for investment.   This open approach has enabled new methods of qualifying companies and funneling investments (via syndicates — or ad hoc VC funds).

So far, AngelList has 35,000 companies listed and has helped fund a couple of thousand.   So, the amount of financing provided is still fairly small.  However, that’s likely to change once the rules surrounding the JOBs Act small business financing provision are solidified.  That Act makes it possible for start-ups to essentially become public companies without filing or operating according to public company accounting rules as long as the amounts raised are small ($1-2 m range).

The JOBs Act provision means lots of new, relatively dumb money.  This means that we may see a big bubble in the VC-lite approach.  However, does this Open-VC approach get us where we need to go in order to fully realize the potential to revitalize the American Dream?

I don’t think so.  Not in the long run.  Simply, the VC-lite approach isn’t direct enough.  It’s still too costly, slow, and uncertain.

Why?  It uses equity, shares of ownership in a company.  Equity is a medieval approach to organizational control.  The way it works is too complex, costly, slow and too uncertain to scale to the levels we need to see.   Worse, that complexity and uncertainty is easily manipulated by the middlemen we need to put out of business in order to make this system efficient.

On a side note,  the founder of AngelList, Naval Ravikant, built AngelList as a way to disrupt an industry that cheated him out of a financial return on a company he helped create.  They maintained that the stock he held was worthless and forced him out, only later to sell it at a nice return.  Despite that, AngelList’s use of equity approach to investing means it does little to fix the mechanisms that make that bad behavior possible.    

So, what am I looking for?

A method of financing that:

  • makes it possible to finance tens of thousands of micro-companies a day at a very low cost and with high degrees of success.
  • is easy for almost everyone to participate in as both a entrepreneur and an investor.
  • minimizes bad behavior, squeezes out middlemen, and avoids bubbles.

Pre-Sales Financing

The method of financing that works for me looks like what is going on at Kickstarter.  It uses a method called pre-sales of a product that an entrepreneur is interested in building.

Simply, in order to raise money, an entrepreneur  needs to do the following:

  • Develop a product that customers want and prototype it.  It has to be novel and something not commonly available.
  • Build a community of customers that are enthusiastic about the product and are willing to buy it because they want to see it built.  By video, blog and other media.
  • Raise money from the community and deliver the product.

This method of financing can be used at the early start up phase all the way through to a mature product (software, media, or hardware).  In fact, there are few companies where the initial product is so complex and costly that it can’t finance its growth this way (even some of the huge products I built in the past could have been built using this bootstrap had it existed then).

So far, this approach is getting a considerable amount of traction.  Here’s the numbers as of today.

  • $844 million total dollars pledged to Kickstarter projects
  • 50,600 Successfully funded projects
  • 5,041,067 Total backers

Note: some of these pledges were donations, not a purchase of some future product, but they are the minority.

I think this method of financing fits my requirements (above).  Some features I particularly like:

  • It forces start-ups to be disciplined.  To know what they are going to build before they take outside money.
  • It forces start-ups to build a community of customers as it raises money, making future success MUCH more likely.
  • It hides complexity by eliminating the extreme uncertainty of equity. With pre-sales financing, the question is simple: Will this person make and deliver this product?  Yes or no?
  • It’s better for the entrepreneur, by far.  Equity financing or revenue from pre-sales isn’t even a debate for anybody that’s been through the process.

This is a bit long and rambling, but I think I made my point.  In sum, I believe this method of financing will become the dominant form, particularly as highly novel products begin to encroach mass produced products in the marketplace.

Of course, I may be missing something.  That’s where you come it.  Feedback me.

JR

Join the movement to restore America's prosperity

Discussion — 9 Responses

  • Javier October 26, 2013 on 12:19 am

    good job

    Reply
  • Melvin October 26, 2013 on 5:14 pm

    Thanks

    Reply
  • GoneSilent October 28, 2013 on 4:13 pm

    Hybrid of both. I know a few projects on kickstarter right now that have had funding rounds based on reaching the goal on crowd funding with kickstarter. The number of eye balls that the site brings gives great validation of demand.

    Reply
    • John Robb GoneSilent October 28, 2013 on 5:03 pm

      Exactly. JR

      Reply
  • David L Kline October 28, 2013 on 6:51 pm

    Makes sense to me. I discovered silnylon–probably linked to something on one of your posts–and couldn’t find the minimalist rain/wind gear I wanted. So I ordered material, designed and made one myself. Works fine. 3.2 oz. Pocketable. How about using the prepurchase system to link an idea with a crafts person with potential customers?

    Reply
    • John Robb David L Kline October 28, 2013 on 7:28 pm

      David,

      There really isn’t a good word for the practice — pre-production? community financing? All better than equity sales.

      JR

      Reply
  • C November 7, 2013 on 9:43 pm

    Something like Kivu?

    Reply
    • John Robb C November 8, 2013 on 4:11 am

      Micro loans are just debt (some run at triple digit interest rates — that’s even worse than the credit card usury we get in the US). I’d like to see micro-customer financing instead. Now that would be a breakthrough. That way, you get going w/o debt.

      Reply