How about a qualified “it depends”?

You’re building a startup that’s creating a healthier protein bar or a better solar panel. You’re signing up initial customers, but you’re not a trendy AI startup. You need money for production and inventory, not to mention paying your employees.

But the VCs aren’t biting and angel investors are turning up their collective noses. Family offices just laugh and say come back when you’ve hit $10M in revenues.

Then you see an advertisement for a crowdfunding platform and it hits you on the head — the VCs don’t get it, but regular people do. Maybe you can’t get a single check for the $5M you need from a16z or Khosla, but could you get $1000 checks from 5000 individual investors?

The idea of raising funding on an equity crowdfunding platform is appealing. And sounds so easy. Should you do it?

If you’re looking for a simple yes or no answer, sorry, you won’t get that from me. Crowdfunding has its uses. But it’s rarely a silver bullet for funding challenges.

Posting your startup on a crowdfunding platform is easy. But that will cost money and accomplish nothing.

To be successful requires a significant budget, slick marketing, and knowing how to game the algorithms. It’s far more difficult than founders expect. If you can’t raise from experienced angels writing $25K checks, are you going to do any better raising from the inexperienced public writing $1K checks? And if the pros think it’s a bad deal with little chance of exit, should you even be taking money from the general public that doesn’t understand venture math and the very low chance of success?

Crowdfunding Basics

Traditional venture investing in the US is legally limited to accredited investors — venture funds and rich people — plus founders, friends, and family. However, there is an exception, called Reg CF (for crowdfunding), that allows startups to raise up to $5M per year from the general public.

People with annual incomes less than $124,000 can invest the greater of $2,500 or 5% of their income per year. Those with incomes of over $124,000 can invest up to 10% of their annual income.

The crowdfunding must be handled through an SEC-registered platform. The biggest ones are StartEngine, WeFunder, and SeedInvest, though there are a handful of others.

Instead of having a thousand individual investors on the startup’s cap table, the crowdfunding platform aggregates all the investments into a single SPV (a separate LLC that exists only to hold the stock in the company) so that legally, there is only one investor in the company. This is great for the startup, but adds to the costs you’ll have to pay.

Crowdfunding Costs

Fees differ by platform, of course, but expect to pay 7–12% of the raised amount, plus 2% in equity, plus a flat fee of around $10K. If you’re raising $100K, that comes to around $22K, which is pretty hefty. If you’re raising $1M, it’s more like $112K, which is a little more manageable as a percentage, but still far from cheap.

The real costs, though, are usually in the marketing. If you have your own investors already lined up, you may only need the platform to handle the logistics for you. But if, like most startups, you’re expecting the platform to find investors for you, you’ll need to invest in marketing. If you simply post your pitch deck and fill out the registration to post on the site, you’re unlikely to get any takers.

To start with, you’ll need a slick video to introduce the product and company. That could cost $20K or so. You may also need to pay the platform for marketing services to help get the most from the campaign. Add in legal fees and accounting, and it’s best to budget $50K in upfront costs.

$50K is nothing if the platform raises $5M for you. But, even paying $50K, don’t expect the money to gush in like water during a hurricane.

Crowdfunding Hacks

Let’s be clear and state the obvious. The crowdfunding platforms don’t exist to help you raise money. They exist to make money for themselves (and their investors.) They do that by matching you with potential investors for you to sell equity in your startup.

Like any sales platform such as Amazon, eBay, and Zillow where screen placement is their most valuable commodity, they have sophisticated (but still kinda dumb) algorithms to prioritize the listings that make them the most money.

You probably have at most one day on the front page before you quickly sink to the back. Unless…you’re signing up investors and generating revenues for them faster than the other thousand startups, all with their hands out.

To succeed, you need a well-prepared marketing blitz. You need a collection of investors ready to sign up and invest the minute your campaign goes live. Which means you’re bringing them investors rather than the other way around, and paying them a percentage for every dollar they invest. That’s painful, especially for the bigger investors putting in $25K or $100K that you could otherwise have invest directly at no cost.

But the more funding you get, the more you’ll get featured. The longer you’ll stay on their front pages. The more email blasts that will include you. The longer you’ll stay at the top of searches.

If you think you can sit back and watch the dollars roll in, sorry. You’ll need to devote all of your time for weeks on preparing the campaign and then executing. Email blasts. Social media posts. Webinars. Begging customers for testimonials. Answering investor questions.

If you do all that, and do it well, will it work? Will you raise $500K or $10 million? Maybe.

What Works and What Doesn’t in Crowdfunding

The difference between crowdfunding, angel groups, and VCs is the audience. VCs and angels should have some expertise in your space and be willing to spend weeks on diligence before investing.

Crowdfunding , by contrast, is pitched to the general public. The product needs to be easy to understand. The opportunity needs to get people excited enough to make what is essentially a donation to the company.

Consumer products are easiest. Invented a better protein bar or a low calorie wine? How about a gaming or gambling platform? The product is easy to understand. If you say the product is sold in Krogers and Walmart, everyone understand what that means.

If you want to present a new battery chemistry, you have to find a way to make it easy for the public. The chance to save the world through EVs that are cheaper and safer can be a compelling story. But if you’re developing a battery component like a separator or electrolyte, that can be challenging to explain in ten seconds.

In general, crowdfunding works best for consumer products. For deeptech, it’s better to focus on finding the experts who understand the technology and industry.

The Downside of Crowdfunding

In addition to the time and cost of crowdfunding from the public, and the feeding and care of a thousand investors asking when they can expect to get a return, there’s one really critical downside.

Once you raise with crowdfunding, it becomes far more difficult to raise later rounds from angels and VCs.

There’s a deep stigma attached to crowdfunding. The reasons aren’t exactly clear and certainly aren’t fair, but there’s a consensus among professional investors that if you’ve raised from the public, you’re not a professional and don’t fit into the venture world.

Of course, if you use the money from crowdfunding to catapult yourself to tens of millions in revenues, the early transgression will be overlooked. But if you raise $500K in a crowdfunded pre-seed round, that makes it far harder to raise the next $2M in the seed round from VCs and angels.

While I disagree with this thinking in general, the specific cases I’ve seen certainly fit this view. Most, though not all, of the people who resort to crowdfunding really don’t know what they’re doing other than chasing dollars wherever they think they can find them.

One factor contributing to the stigma is that most crowdfunding deals are bad for those public investors. The valuations are too high because the platforms encourage you to use marketing gimmicks like discounts for the first people to invest and kickers for larger investments, so the nominal valuation has to be set high. Plus the valuation is usually set by the founders’ inflated view of their worth rather than through negotiation with investors. Crowdfunded investments are also usually in common shares instead of preferred, which few professional investors would accept.

So in the next round, you’ll often have to raise at a lower valuation, and many of your common share are held by outsiders rather than the founders and employees. It’s an awkward situation with a down round right from the start that’s easiest to avoid.

That’s not to say crowdfunding platforms don’t have their uses. One deal that I invested in was a startup that already had hundreds of millions in revenues. They were raising a final round of funding from angel investors and company supporters prior to planned IPO.

Investors willing to write checks of at least $25K could invest directly with the company. Anyone wanting to write a smaller check, or who wasn’t an accredited investor, could do so on WeFunder at the same terms. The company had their own investors, so they were mostly uses the platform for logistics of handling small checks. Of course, with all the cash flowing in, the platform highlighted the company, drawing additional public investment.

Alternative to Equity Crowdfunding — Product Crowdfunding

Especially for consumer products, an alternative to equity crowdfunding is product crowdfunding on platforms like Kickstater and Indiegogo.

Unlike equity crowdfunding where the public is purchasing shares in the company, on a product crowdfunding platform, people are pre-purchasing your product.

Making a better coffee maker, 3D-printed sneaker, or sleep-enhancing pillow? Get 10,000 people to pay you upfront to make it. This can cover your production costs. And by proving there is a market for the product, you impress the hell out of investors. Though better make sure the product is delivered on time and works well because later investors will read the reviews!

Crowdfunding — Yes or No?

The simple answer is that if you’re following the traditional venture path, it’s best to avoid equity crowdfunding.

If you’re developing a product that resonates with the general public, crowdfunding is an option, though in most cases, it an option of last resort.

If you do decide to go the crowdfunding route, make sure to understand the costs as well as what’s required to be successful.

Like everything else in the venture world, crowdfunding follows the power law. One out of a hundred startups, usually the ones that know how to play the system, raise millions from crowdfunding. Those are the stories you read about. Those are the stories the platforms make sure you hear. But the vast majority of startups pay a lot and raise little.

So if you decide to do crowdfunding, go in with your eyes wide open and be sure to do it right.