The last decade and a half has been a golden age for the hi-tech industry. From the iPhone, social media and Netflix to cloud computing, online shopping and blockchain, the industry is constantly in a cycle of disruption and innovation. The tech industry even played a major role in the global economic recovery following the great recession of 2008-09.
Last year startups raised a record $643 billion through global venture capital investment, but so far 2022 has been another story. Falling tech stocks, soaring inflation, a war in Eastern Europe and a plethora of other factors are straining the global economy, making fundraising even more challenging than usual. The old mantra in tech that market downturns wash away the weak startups holds weight, but it doesn’t mean the strong ones can survive without funding.
What other options do serious, yet cash-strapped startups have to raise funds in these harsh economic times?
Crowdfunding as a Substitute
When everything from big tech firms and small startups are laying off parts of their workforce, it means money is tight and small startups must get creative in order to stay afloat. As VCs’ wallets tighten, the need for startups to find alternative sources of funding is leading many to turn to crowdfund platforms.
There are three primary types of crowdfunding campaigns commonly used today. Rewards-based campaigns raise capital and then reward donors with a tangible gift, such as early access to the company product, without having to give up equity in the company. Donation-based essentially raises capital as a charity, typically to support a social initiative or business that has deep roots in a specific community and needs assistance to survive. The third type, and one most relevant for startups, is equity-based.
Equity crowdfunding is the logical choice for startups affected by the slumping market because it attracts investors seeking out disruptive products and projects. It also most closely resembles the process of courting VCs because it requires a strong business pitch to sell the investor on the idea or product.
The downside is there have been too many fraudulent projects and companies exploiting these platforms and not fulfilling the stated objectives and mission. This reputation makes investors reluctant to invest in a project that may sound revolutionary. Navigating the hype and deciphering between the real projects and the scams on many major crowdfunding platforms is a challenge because there is a serious lack of transparency.
Crowdfunding platforms owe their investors and donors transparency and in order to reclaim their credibility, these platforms must take measures to hold project owners accountable.
Building Accountability
Serious investors aren’t going to waste their time (and money) if there are inherent risks with the infrastructure supporting the funding process.
There are several methods and tools that platforms can leverage to enhance their transparency and credibility. One method that can enhance a platform’s credibility which in turn contributes to increased transparency is to release the funds in stages, upon completing pre-determined milestones. This means that if an AI startup raises $200,000 during its campaign, it may only unlock $75,000 initially to go towards the development of its primary algorithm. Once it has a beta version of the product ready, it could unleash another $50,000, for example, to go towards its marketing and go-to-market efforts. If the startup fails to reach the initial milestone, then the remaining funds can be returned to the investors.
AI is another tool that can be leveraged by crowdfunding to help protect investors from fraudulent projects. Through an AI algorithm, crowdfunding platforms can better vet projects by scanning for copyright infringements and other red flags that investors would have otherwise overlooked.
Crowdfunding, and specifically equity crowdfunding, can provide startups struggling to attract VC funding amid the brutal bear market the cash they need to further advance their product, solution or service. But, investors are likely to err on the side of caution when it comes to investing in a startup via crowdfunding. If crowdfunding platforms demonstrate that they can provide transparency and a safety net for investors to prevent them from being scammed, the industry can fill a major void in the hi-tech industry, and help many young, yet solid startups stay afloat and ready for the next bull market when the VC tap will be turned on again.
Claudiu Minea is the co-founder and CEO of SeedOn.
