9 pitfalls of crowdfunding your tech startup

The harsh truth that entrepreneurs need to know

Jan Hammer, a respected venture capitalist at Index Ventures recently had a post up on TechCityNews where he answered the question “If I choose crowdfunding will it put off future venture capitalists?” He offered a venture capitalist’s view and painted a pretty positive picture of crowdfunding so I figured I’d let other startup founders in on the harsh truth instead. As a software based startup founder, my view on this is clear:

Just don’t do it.

There is way too much stigma around crowdfunding, and people like Jan tend to focus only on the winners, the successfully backed startups, rather than the hundreds of startups who do not manage to successfully crowdfund. Also nearly all of his examples were hardware startups that can really benefit from the pre-sales model of crowdfunding platforms like Kickstarter, but not necessarily from equity crowdfunding.

Don’t get me wrong, crowdfunding has proved extremely successful for hardware startups, art and film projects and the like. But for software specific tech startups it usually doesn’t make sense to do a Kickstarter campaign. Rather, these startups tend to focus on equity crowdfunding, with the major platforms being Angel List in the US and Crowdcube, Seedrs and a few others in the UK.

I have a ton of respect for the guys behind equity crowdfunding, especially Darren Westlake of Crowdcube. In fact I remember chatting with him about the challenges of crowdfunding back when he was still developing the concept behind his pioneering, and now hugely successful equity based crowdfunding platform. And no doubt there have been a lot of startups that have seen great success on platforms like his, however, the problem with crowdfunding lies purely in negative signals.

As an early stage tech startup struggling to survive and hoping to just make it to the next fundraise, negative signals are the worst possible thing you can give investors. It is all about painting a positive picture, and keeping the momentum going. Traction, no matter how little, is the lifeblood of a startup.

So then why do I believe that crowdfunding raises a negative signal to investors?

1. It shows that you’re not an A+/star/winning startup

If you have to consider alternatives (which truthfully crowdfunding is) it means that you aren’t effectively raising from angels or VCs or can’t get their interest.

2. Equity crowdfunding is still too nascent

Crowdfunding is not a proven model and will take years to become as mainstream as angel or venture investing.

3. For founders, crowdfunding is more often than not a backup option

Founders who aren’t gaining headway with angels or VCs tend to look at crowdfunding as a last resort, a backup of sorts that they can fall back on before burning through their fast depleting reservoir of cash.

4. The crowd tends to fund only once

Startups take time to grow and build, and often times angels or institutional investors reinvest after a major pivot, or to fend off a competitive threat. However with the crowd, its very difficult to keep going back for more money.

5. The crowd’s money isn’t necessarily smart money

It is said again and again that early stage startups shouldn’t settle for just anyone’s money, that they should chase smart money. Well from the crowd, expect a lot of people who don’t know your business, aren’t willing to invest the time to get to know it, waste a lot of time with inane questions, have unrealistic expectations, act like bedroom venture capitalists, and generally bog you down when you should be out building your business.

6. Crowdfunding isn’t neat in a legal sense

VCs and future investors will want to see a clean cap table, and although many of the big crowdfunding platforms have workarounds to this issue, traditional investors still feel it’s bound to be a legal nightmare and hence won’t be as willing to back crowdfunded startups.

7. You may need to explain why you failed at crowdfunding

As much as VCs say they don’t mind funding a crowdfunded startup, even successfully crowdfunded startups raise negative signals with VCs. So if unfortunately you weren’t even one of the successful ones, but rather one of the majority of startups that don’t successfully raise from the crowd, it becomes extremely challenging to explain to a VC why you weren’t able to raise through crowdfunding, and to convince them why you’re still attractive as an investment.

8. Where are the big name crowdfunded startups?

Unless you’re a hardware startup, it will be very difficult to count on your hand the number of successfully crowdfunded tech startups that are recognizable; such as the Ubers, Airbnbs, Dropboxes of the world.

9. You don’t get a second chance

Crowdfunding creates a lot of visibility. And as an early stage startup you tend to face a ton of rejection. Being able to dust yourself off after an investor says no and go after another is a valuable and admirable trait that most successful founders have, and often you get that crucial one yes after 99 consecutive no’s. However because of the time investment, scale and visibility of a crowdfunding campaign, a failure could mean that you don’t get a second chance.

If you feel that crowdfunding is still a viable option for software tech startups, and would like to have a chat, I’d love to hear from you. Drop me an email at ali@lutebox.com.