Will Davis and Evan Baehr, co-founders of an Austin, Texas, tech company called Outbox, saw how tight the venture capital business has gotten when they went looking for money a few months back. When they'd first raised funds two years ago, Silicon Valley investors had been eager to deal. Then Facebook's IPO flop popped that bubble.
But aspiring Zucks are in luck: Entrepreneurs have a growing number of alternatives, from new online platforms for meeting investors to nascent federal "crowdfunding" rules that aim to let moms and pops back startups.
Some startup CEOs say they're perfectly happy to raise money without giving a big share of their companies to venture firms. For others, it's a necessity born of math: The latest Moneytree report, released last month by the National Venture Capital Association and PricewaterhouseCoopers, found that VC funding for "seed stage" companies continued to drop toward historic lows, as venture investors seek less risky bets.
"That industry's going through a huge restructuring right now," said Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. As the number of firms shrinks amid poor returns, venture investing is becoming concentrated in the hands of a few mega-funds, he and others note.
Meanwhile, many wealthy angel investors are now following suit, according to a survey Sohl recently conducted that found just 35 percent of angel money is going into the earliest startups.
The reduced options have opened the door to online exchanges like AngelList, a matchmaking service for entrepreneurs and financiers that last year expanded its services to include small investors.
Outbox -- which offers a service to pick up your mail, scan it and send you digital copies (winnowed of junk) -- used AngelList to raise $5 million in 10 days, Davis said. While some of that came from venture firms, the vast majority of the 100 investors were individuals cutting four or five-figure checks.
Joining the Crowd
While AngelList and similar services like FundersClub require their members to be accredited -- which, in the parlance of the Securities and Exchange Commission, means having substantial financial resources and an investing track record -- anybody with a credit card can invest as little as $1 in fledgling businesses through sites like Kickstarter and Indiegogo.
Massolution, a research firm in Los Angeles, reports there are now hundreds of crowdfunding platforms. Last year, they collectively channeled $2.7 billion to entrepreneurs, nearly double the previous year's tally.
Massolution CEO Carl Esposti cites the example of Pebble Technology, a Palo Alto startup that had trouble persuading venture firms to back its product: a customizable wristwatch that interacts with a user's smartphone. In the spring, Pebble set up a Kickstarter campaign and raised an eye-popping $10 million from more than 68,000 people eager to buy the device.
"It beats any focus group in terms of how the market is going to respond to your product," Esposti said. "And it puts you in much stronger position to raise your Series A rounds from venture capitalists. Lots of entrepreneurs are now thinking of this as a primary strategy."
Joining the crowd
Current SEC rules restrict crowdfunding sites in the United States to investing in specific projects, such as the Pebble watch, rather than buying a piece of the company itself. But that's expected to change late this year when federal officials hammer out new rules as part of sweeping legislation called the JOBS Act (short for Jumpstart Our Business Startups).
Portions of the act already allow companies to file initial public offering plans confidentially, which advocates expect will encourage more companies to go public. A newer provision, which has yet to be finalized, makes it easier to directly solicit funding from accredited investors.
"It gives companies tremendous flexibility when it comes to raising capital," said Martin Wellington, an attorney with the Davis Polk law firm in Menlo Park who specializes in public and private securities offerings.
What's less clear, experts say, is how the rules will be developed for unaccredited investors. Though many entrepreneurs are eager to tap this new funding source, "it's going to bring in people that are just not ready for prime time," said Sohl, the university professor. "Lawsuits probably will increase. People are going to lose money, there's no doubt."
Massolution's Esposti dismisses such fears, arguing that the vast majority of existing crowdfunding exchanges work well -- and will make sure things stay that way to reassure investors. Exchanges that want to participate in the new program will be registered by the SEC, which will limit how much non-accredited investors can pony up each year.
Naysayers' concerns haven't dampened enthusiasm at Wefunder, a Boston-based crowdfunding platform that launched last year promising to let people "invest as little as $1,000 in some of the hottest startups." While it's currently open only to accredited investors, the site's founders have worked closely with federal regulators to set rules for the hoi polloi as well.
Brad Gessler, co-founder of San Francisco startup Poll Everywhere, said he knows of several entrepreneurs who have raised cash via Wefunder.
"It's not smart money," he said, meaning that crowdfunding sites typically can't offer the operational expertise of venture capitalists or veteran angels.
"But there's definitely a camp of people who say dumb money is OK."
Contact Peter Delevett at 408-271-3638. Follow him at Twitter.com/mercwiretap.
A growing number of online portals are bringing together private companies and investors. They include:
AngelList: It has been used by more than 1,000 companies to find accredited investors -- often a mix of "angels" and venture capitalists, but smaller investors can play, too.
CircleUp: San Francisco startup specializes in helping inventors of consumer products such as pet food and organic snacks find investors.
Crowdtilt: "Groupfunding" site backed by Y Combinator lets groups of friends launch funding campaigns for projects or purchases; money is collected via credit card, and the site takes a cut.
FundAnything: The site launched by Donald Trump to offer artists, entrepreneurs and philanthropists "money for their dreams."
FundersClub: It was launched in July 2012 as an "online venture capital firm" whose money comes from individual accredited investors.
Kickstarter: Like rival Indiegogo, best known as a place to find backers for an artistic endeavor or invention, but small tech companies and other businesses can also launch funding campaigns.
Liquidnet: It offers a platform to let private companies sell shares directly to institutional investors.
SecondMarket: The firm also allows for the buying of private-company shares, but by individuals.
Wefunder: It offers "crowdfunding for startups," lets investors put in as little as $1,000 and is making plans to welcome non-accredited investors once federal rules permit.
Source: Staff research