The Future of Business Funding: Super-Angels, Incubators, CrowdFunding and IPO

crowd sourcingBI Research, the new tech-industry intelligence service of Business Insider has published a very interesting take on the funding landscape. 

There are lots of trends people have been talking about in tech financing--"superangels"; delayed IPOs; secondary market sales; and more. But so far, few people have been putting the dots together: the entire financing landscape for companies is changing.  And, excitingly, it's increasingly not just technology companies.

There are many new financing options for growing companies that weren't available a decade ago.Here's how we break them down:

  • Crowdfunding

  • Accelerators

  • Super-angels

  • Late-stage private equity

  • The long-delayed IPO

Crowdfunding

Crowdfunding startups has long been a dream deferred. But it's finally happening. Direct crowdfunding via equity financing is still a big no-no, because SEC rules make it difficult for non-accredited investors to invest in startups. But exciting things are going on.

AngelList

One of the most exciting such examples is AngelList, a "Match.com for investors and startups" that lets startups vie for capital from angels and (increasingly) VC firms. AngelList has seen torrid growth on the back of rising early-stage valuations in Silicon Valley. And it has also been expanding horizontally and geographically.

There are non-tech companies listed on AngelList, along with companies from around the world. AngelList is not technically crowdfunding--it just makes it easier for startups to get accredited investors' attention and get funding--but it is certainly an early step in that direction.

Kickstarter

Another exciting example is Kickstarter. Kickstarter is a startup that helps creatives of any kind raise funding for entrepreneurial projects. Entrepreneurs on Kickstarter don't sell equity in their companies--they basically seek donations or pre-payments for perks. So, if you want to self-publish a book, you might set a target goal of $10,000, promise an autographed special edition to those who pledge $100, a regular special edition for those who pledge $50 and a regular book for those who pledge $20. Once the number of pledges hits your goal, people's credit cards are charged and off you go. Kickstarter helped raise $8.8 million for entrepreneurs in September and is fast-growing, with many projects exceeding their goals as the great infographic above from Bloomberg BusinessWeek shows (click to enlarge).

Another model is peer-to-peer lending marketplaces like Lending Club. These marketplaces appeal to both lenders and investors.

By aggregating loans, they can at least in theory offer better terms to both sides, and manage risk better through data. Right now Lending Club doesn't offer loans directly to businesses,. But it helps businesses get started, the way many entrepreneurs' first business angels were Visa and MasterCard.

More importantly, it's the future of the model that is interesting. The internet can broaden and deepen marketplaces for debt in a much more efficient way. If the SEC doesn't quash it (it already shut down Lending Club for a while), it's not a stretch to imagine a small business owner with several quarters of cashflows and financials logging on to a website, filling out a form, and offering bonds at an appropriate interest rate into a marketplace.

Crowdfunding can mesh with new forms of financing that offer an interesting risk/reward profile relative to equity or debt, such as revenue-based lending, where money is loaned against a percentage of a business's revenues.

AngelList, Kickstarter, peer-to-peer lending... It's not quite equity-based crowd-funding, but we've come a long way from "friends, family and fools."

Accelerators

So far, accelerators like Y Combinator, Seedcamp and TechStars have been a mostly tech-centric phenomenon. These accelerators coach startups for a short period in exchange for a small slice of equity and then introduce them to investors who might invest.

The model has been criticized as being the reincarnation of the infamous "incubators" of the dot-com bubble, but this time around the model is sustainable, because of the radically new capital efficiency of web businesses. 

But it's possible that this model could be expanded to other areas or models. Various forms of incubators, after all, fill a real need for entrepreneurs, especially inexperienced ones, from office space to mentorship. And the web is making startup costs cheaper for all kinds of businesses, not just online-only businesses, especially in a Kickstarter-Lending Club world.

These accelerators have tremendous demand: they typically admit around 1% of applicants ("More selective than Harvard or Yale!") and raise six if not seven figure amounts right out of the gate (even though Y Combinator and TechStars technically invest only 5 figure amounts, both are accompanied by funds that grant 6 figure amounts to every inductee, before the companies raise any money on their own).

To be sure, the excitement around these is driven at least in part by the broader excitement around early stage startups, which is described as everything from "frothy" to "a bubble." But, at least in tech, the accelerator model is sustainable, and it's not as unlikely as many people think that it could expand beyond tech, as services like AngelList have.

Super-Angels now taking place of early-stage VC

For a while, the conventional wisdom on venture capital was fairly straightforward: because of the dotcom bubble, VCs had grown too fat and raised too much money. This wasn't apparent because funds are typically raised for 10 years, but now was the time of reckoning, when VCs would start dropping like flies and even the top of the industry would have to slim down. 

Then, two funny things happened:

  • Plenty of small funds ($20-$50 million) started popping up, in Silicon Valley and elsewhere;
  • Some funds have taken to raising huge funds, sometimes in the billions of dollars.

What's going on?

VC is not just slimming down (though it is, as the chart above shows), it is completely reconfiguring. On the side of the small VC funds (the so-called "superangels"), they are largely happening for two reasons: 

  • Web businesses are incredibly capital efficient and so smaller fund sizes make sense (the demand side);
  • Through sheer math, smaller funds have a better time delivering ROI to their investors (the supply side). 

On the side of the mega funds, here's what's going on: there is a "flight to quality" for LPs (Limited Partners, the institutional investors who invest in venture firms) who have gotten battered by low VC returns over the past decade (not just in tech--biotech and cleantech have been disappointments as well). Even though they are cutting their allocation for venture firms overall, that's still a very large pie, and more of that remaining pie is going to the very top funds. 

So instead of getting a VC industry that looks much the same except a lot smaller, we're getting a VC industry that's smaller but also very different, with a bunch of very small funds on one hand, and a handful of very, very large funds on the other hand.

Stuck in the middle with them, some VC funds that are sticking to the traditional model, like Union Square Ventures and Sequoia Capital, are thriving. (And others dying.)

For companies, this means that there is much more of a continuum from the very early stage through to the pre-IPO stage. But even the pre-IPO stage is changing, because the IPO is much later. We call this the cash-rich adolescence.

Fr more information see the published article at Business Insider.

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