Five things you need to know about the economics of crowdfunding

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Financial Post | Chris Grouchy, The Next 36 | July 25, 2014

CaptureChristian Catalini

With Kickstarter projects now the topic of dinner party conversations, it’s important for entrepreneurs to understand the economics of crowdfunding platforms. These platforms can be launch pads for complex hardware to be brought to the world, or allow artists, makers, and people with far-reaching ideas to get exposure. But before you can leverage them as part of your arsenal of funding avenues you need to know how.

The Next 36 allows entrepreneurs to learn about innovation from some of the best professors at leading global universities. Earlier in June, Christian Catalini, assistant professor of MIT’s Sloan School of Management, travelled to Toronto to deliver a lecture on crowdfunding. I had the opportunity to sit in. Here are some of my key takeaways:

Hot projects attract a larger crowd The crowdfunding culture is about winning and hopping on projects that will win — and win big. Our propensity to back a project increases the more funds that a project has already accumulated, Prof. Catalini said. In practical terms, the closer a project is to reaching its goal, the more capital will be received.

Information disclosure One of the major disincentives of crowdfunding is that competition in your space will immediately be able to identify your market strategy and value propositions before you even enter. Especially in the hardware space where product iterations are far from cheap and time between iteration cycles is greater than software, the incumbent could, in theory, use its access to capital to make their product just as good as yours — or better — in a shorter amount of time.

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Changes in the VC landscape The explosion of infant ventures that have emerged from crowdfunding technology may have the VC community feeling a bit antiquated. Sam Altman, president of U.S. accelerator Y-Combinator, recently wrote in a blog titled Valuations, “Crowdfunding (probably the most important new force in startup investing) is providing more competition for early-stage investments, and hedge funds and private equity firms are starting to do a lot more late-stage investing.” That means startups now have the ability to receive early-stage, non-dilutive capital on crowdfunding platforms.

A commonly known piece of value provided by angel investors and VCs is that they can provide advice to the entrepreneurs they fund. However, this isn’t possible or always relevant when an entrepreneur seeks funding through crowdfunding platforms. As Robert Schiff writes in McKinsey on Society, “Just because you live in the United States doesn’t mean you have very much advice to give an entrepreneur in Uganda.”

Prof. Catalini makes the argument that many “crowdfunders” may not be the best advisors for infant startups, whereas VC firms can leverage their expertise to help their portfolio of companies succeed (see http://a16z.com/team/ for a good example of this). By turning to crowdfunding, some startups could be crowding out the mentorship that comes with professional investors.

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada crowdfunding hub providing education, advocacy and networking opportunities in the rapidly evolving crowdfunding industry. NCFA Canada is a community-based, membership-driven entity that was formed at the grass roots level to fill a national need in the market place. Join our growing network of industry stakeholders, fundraisers and investors. Increase your organization’s profile and gain access to a dynamic group of industry front runners. Learn more About Us | About Crowdfunding or contact us at casano@ncfacanada.org.

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