The Evolution of Active Investment Models — How the Web Encourages Investor Support Beyond Capital
The Two Sides of Investment
Historically the concept of investment has always been about putting money to efficient use. From the view of an investor efficient use means to gain a high return on investment. The main rationale behind this is thus to raise the value of the startup — usually within a period of 7–10 years, which constitutes a typical VC cycle — and then sell it for high return.
However, for a start-up the efficient use of capital may entail an entirely different meaning. For the purpose of my argument, let’s assume an entrepreneur’s main goal is to build a sustainable and long lasting business. This goal is not only desirable from an entrepreneurial perspective, but also from an economic perspective as it entails the creation of real economic value in the form of jobs and products and services that are consumed.
Looking at these two different notions as how to put money to efficient use, one can already see that the goal of investors and serious entrepreneurs do not always align very well. The main reason for this is that investors often pursue pump and dump strategies with the main goal to increase a startup’s price. Such a strategy usually goes at the expense of startups who come under enormous pressure due to valuations that do not reflect their real value. This can make it more difficult for startups to secure funding in follow-up investment rounds. At the same time entrepreneurs do not get the resources and the help they need to build a sustainable and healthy business. As a result of this, a high percentage of startups fails despite securing funding from institutional investors.
Startups Need More Than Mere Capital to Succeed
In recent years lower entry barriers led to a rising number of entrepreneurs starting new businesses. This led to marketplaces being flooded with companies offering new products and services. While this development is desirable from a consumer side — consumers are now faced with an overwhelming number of options — startups are faced with an increased number of competitors who they compete for investors and consumers. One consequence of this is that it is getting increasingly difficult for today’s startups to stand out from the pack and to be successful.
This means for startups to not get outcompeted by fellow startups they don’t just have to build a great product; they also have to be masters of operations, marketing, sales, design and customer support. Mastering these tasks comes not naturally for many entrepreneurs, especially those who have to do this for the first time. One investment model that seems to account for these needs, at least to some degree, is Angel capital. Business Angels are investors that do not only take a financial interest in the company they are investing in but they are also eager to engage in the development of this company. By doing so business angels take on a more active role in supporting startups by offering them mentorship as well as providing them with important developmental resources (e.g. production facilities, a business network, expertise etc.). Another positive effect of this investment constellation is that the interests of a business angel and the start-up are more closely aligned since both are working towards a common goal, that is building a sustainable business.
While angel capital seems to be a promising concept for many startups that look for more than mere money, the scope and scale of this type of capital is largely constrained to certain geographic areas and types of businesses (i.e., business angels usually operate in economically developed areas and primarily invest in businesses they are familiar with).
New Technologies Bring New Investment Opportunities
Despite there being a shortage of angel capital the outlook for startups who are seeking active investments is not as grim as it might seem. Thus, with the rise of the web a variety of new interesting investment models emerged that allow entrepreneurs not only more flexible funding conditions, but that also give investors the possibility to actively engage in the company’s development. This has not only advantages for startups but also for investors who are provided with an additional lever to directly influence the success of the startup they invested in.
“In times where it seems increasingly difficult to increase profits, active investment models provide investors with an additional lever to maximize the impact of their investments on the success of startups. These models differ from traditional investment models in that investors do not passively seek new rents. Instead, they actively create new rents for the start-up and for themselves.”
The most well known example employing such web-based active investment models is crowdfunding. Crowdfunding, beyond allowing to invest money into startups, further provides users with various options to provide feedback on certain aspects of a startup business. For example, in the case of reward-based crowdfunding where investors are offered the company’s product in return for their investment they can give feedback on certain product configurations, required product features as well as preferred pricing and distribution strategies for the product. Even more investors can also act as marketing advocates, thereby facilitating awareness and ultimately driving sales of the company’s products and services.
In the case of equity-based crowdfunding where users obtain shares in exchange for their investment users can help determine the value of a company by giving feedback on preferred share prices and equity stakes. Beyond this equity crowdfunding allows investors to obtain equity for various other contributions. For example, in the case of the Hyperloop, a new high speed train that travels through a vacuum tube, an equity pool was created for users who supported the company by developing and validating concepts to solve the technological challenges of the project as well as for users who contributed rights of way (e.g., land where the Hyperloop could be tested).
Even more interesting crowdfunding models engage investors in the future development of a company’s business. One example is the recent crowdfunding campaign of Hackernoon, a community-based media blog, which promises investors not only a share in the future returns of the company, but also encourages them to become writers on the platform by rewarding them with free publication services such as article reviews and article promotion. This is an interesting investment model as it does not only allow Hackernoon to secure investment, but also to build its business by leveraging its investor base to produce content for the platform.
A similar principle is employed by a variety of block-chain projects which — through so called token sales — provide users with tokens in return for their investment. In their simplest form these tokens provide investors access to a startups future services or part of the rewards obtained from these services. However, an even smarter way to use these tokens might be to integrate investors into the company’s business model. This can take on many different forms. For example, startups can reward investors with additional tokens for drawing in additional capital givers from their network. Similarly, tokens can be used to reward investors for providing their expertise or work. How such a model may look like is outlined by OpenMaketCap where users are rewarded with tokens for providing, validating and curating market data on block-chain projects.
Conclusion
To sum it up web-based active investment models offer several advantages over conventional investment models:
- They allow more flexible investment models that startups can tailor to their individual needs.
- They reward active investors to a higher degree.
- They ensure better alignment of interests between entrepreneurs, investors and other parties, thereby increasing the chances of a successful investment.
While a wise man once said I do not invest in a business that I do not understand another wisdom future investors should take to heart is not to invest in businesses they cannot provide value to. The main reason for this is that investors who can provide a start-up with strategic resources in addition to funding have a higher leverage on its potential return on investment. This is increasingly important in times where profit margins are decreasing due to increased competition among startups and where new ventures have various other possibilities to obtain capital (e.g., through such means as ICOs or Crowdfunding).
As concerns startups they should seriously consider these new types of technologies to raise capital. The main reason for this is that these technologies allow startups to determine investment models that they can specifically tailor to their individual needs.
