Venture capital financing is not the only answer for early-stage businesses seeking initial funding. In this article, with the help of dr. Attila Pintér and Nóra Szeles, we explored the main differences between crowdfunding, which enables direct participation by small investors, and institutional venture capital financing.
We hear and read more and more about crowdfunding, and about online equity crowdfunding. This financing model is a simpler and more accessible form of equity investment for many, as it offers investment opportunities to a wider audience: many people can participate with small amounts of capital in financing businesses seeking community-based funding.
When comparing crowdfunding and venture capital investment, there are significant differences that must be taken into account, as the two investment forms differ, among other things, in their business model, investment terms, investors’ experience and marketing costs. It is important to consider these factors before making a choice.
Let us look at the most important differences.
Complexity of the business model
Crowdfunding is based on broad online marketing, through which even thousands of people can be reached. The larger the company seeking capital, the campaign owner, the online reach of the given platform and its number of followers, the easier it is to address a wider audience. Therefore, if the business model is not sufficiently clear and transparent to many people, and if the idea does not convince them, this will not be the right path to take.
While VCs generally engage experts to assess more complex or specialised investment opportunities, the crowd does not have this option. In the campaign, it is therefore advisable to provide clear feedback on what their investment will result in for them: this will also be included in the term sheet. However, it is difficult to foresee how the idea will work in the future. An understandable, reliable and clear business model is also essential in the case of venture capital investment. Of course, besides the business model, the most important factor is the team itself.
Many small contributions add up
While venture capital investment provides an opportunity for one or more institutional investments, a crowdfunding platform offers an organised investment opportunity for several non-professional investors. In the case of venture capital investment, it is not possible for someone to participate in an equity investment with only a few hundred thousand forints; crowdfunding, however, offers precisely this opportunity by coordinating many small investments. We note that the two forms of investment do not exclude each other. In fact, many venture capital investors also use crowdfunding platforms to open up their own investment to the crowd, allowing them to join the investor’s terms and thereby increase the total amount of equity investment.
Investment terms
The investment terms set during crowdfunding are much more entrepreneur-friendly than in the case of venture capital investment. In the former case, the entrepreneur can raise money according to their own ideas, while in venture capital investment, restrictive and preferential rights must be agreed with the investor. As a result, capital raising depends on the investor’s valuation, timing and conditions.
Smart money – crowd capital
A good investor supports the campaign owner not only with the invested amount, but also provides “smart money” to the entrepreneur by sharing their network capital. This may help the entrepreneur gain access to partners, customers or even a subsequent investment. In this respect, venture capital financing is generally ahead, as the investor usually knows or can reach a broader circle of entrepreneurs. At the same time, many platforms also encourage investors to share how they could help the business grow. The network provided by the crowd is crowd capital. It is also typical that someone who becomes a shareholder in a brand they had previously only been a customer of becomes significantly more loyal to that brand. This is used by many beer brands, cosmetics brands and fashion brands as well.
Mindset and experience
If the goal is to achieve greater social impact and not only to focus on later financial returns, crowdfunding is the right choice, as few investors use their money to support a cause they consider important. However, those investors who also use their investments for such purposes consider the return they receive to be a better world. We note that the industry knowledge and professional experience of a venture capital investor can often provide effective support to the entrepreneur.
Marketing
In crowdfunding, digital and online marketing play a particularly important role, with the aim of reaching and winning over as many people as possible. Through the online forum, the campaign owner can effectively connect with interested parties and introduce them to their product or service. There, they may also ask questions that would not even arise during a legal due diligence process. This is called crowd diligence. In venture capital investment, the emphasis is not on the number of people reached, but on attracting the attention of the right people through the presentation of the project.,
Financeable solutions
Most venture capital funds have a specific industry focus, so we may encounter greater restrictions in relation to their individual investments. Crowdfunding offers more flexible solutions, as if the idea is convincing, many people can participate in it even with small amounts of capital.
Cost
In the case of venture capital investment, although the investor’s expected return is high, as they want to receive as much as possible from the capital, in crowdfunding a relatively high commission must be paid in the event of a successful campaign — this may range between 5% and 10% of the capital raised.
Publicity
Crowdfunding campaigns reach far more people thanks to online platforms. As a result, campaign owners and their products or services receive greater attention. We add, however, that organising an active community of users is not an easy task either.
Valuation
Company valuation between the campaign owner and crowdfunding investors is similar to most online purchases: all information and conditions are available to them, and they may decide whether to invest based on these. In the venture capital investment process, valuation terms do not always remain unchanged. It often happens that, compared to the originally imagined level, the investor asks for a larger shareholding.