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The Big Bang of Crowd Funding: Startups as a Public Asset Class Kevin Lawton July 1, 2010 http://www.trendcaller.com/ Part 3 of “The New Face of Venture Capital”

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Crowd-funding's future is way bigger than Kiva! As of the time of writing, Kiva has facilitated $145M in loans. The 1000th entry on the 2010 Fortune-1000 list (by revenue) had a yearly revenue of $1.5B, or ~10x Kiva's total lending! Crowd-funding today is a tiny & nascent funding model, but it's about to experience a “big bang” that will change the face of startup and content creation -- when it becomes Wall Street's playground . But 1st, let's look at the why the crowd is such a catalytic force...

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Why is the crowd better than VC? <ul><li>Massive diversity. Fundamentally the collective IQ of the crowd works like this. Every time a new member joins who has one or more superior facets of IQ, the collective IQ is raised by those unique facets. That’s why “fresh ideas” matter: </li></ul><ul><li> </li></ul><ul><li>Fascinating quotes from Crowdsourcing : </li></ul><ul><ul><li>“ The novices often provided a crucial tweak that led to a breakthrough” (pg138) </li></ul></ul><ul><ul><li>“ We actually found the odds of a solver's success increased in fields in which they had no formal expertise” (pg151) </li></ul></ul><ul><li>Unleashes existing problem & solution identification (there's both an idea and a solution surplus): </li></ul><ul><ul><li>“ a full 75 percent of successful solvers already knew the solution to the problem” (pg152) </li></ul></ul>

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The conventional VC value <ul><li>Here're some of the top “values” that VC offers, and they're all being disintermediated by the crowd: </li></ul><ul><li> </li></ul><ul><ul><li>Rolodex </li></ul></ul><ul><ul><li>Expertise </li></ul></ul><ul><ul><li>Control of startup funding (“purse strings”) </li></ul></ul><ul><ul><li>Valuation “sophistication” </li></ul></ul><ul><li> </li></ul><ul><li>Let's look at each one... </li></ul>

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Rolodex disintermediated <ul><li>Entrepreneurs to VC: “my social network is bigger than your Rolodex” </li></ul><ul><li> </li></ul><ul><li>Hundreds of social networks are “flattening” networks and bringing people closer in degrees of separation. Below are just a few popular services, a lot of which are freemium: </li></ul><ul><li> </li></ul><ul><ul><li>LinkedIn, Facebook, Plaxo, Twitter, Ning, Xing, Silicon India, Spoke, Jigsaw, cofoundr, e-factor, focus, PartnerUp, Friendster, ... </li></ul></ul><ul><li> </li></ul><ul><li>When ratings algorithms are applied to social networks, it gets even more interesting. And of course, a Rolodex of thousands of crowd investors is much stronger than that of a few VCs. </li></ul>

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Expertise disintermediated <ul><li>One might wonder how much “expertise” VC has left to be disintermediated. Too few of them come from too few years of related operations. Anyways, performance is the only metric that matters, and as The Wisdom of Crowds points out: </li></ul><ul><ul><li>“ ... there is very little correlation between experts' self-assessment and their performance.” </li></ul></ul><ul><li>While diversity raises collective IQ, when like-minded people are added, scarcely any new value results. </li></ul><ul><li>With the right algorithms, it's almost impossible for any panel or set of partners to outperform the right crowd. And there are 1B+ connected people. </li></ul>

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Prediction markets exemplify this From a Predictify talk , the general (1 st graphic) vs the performance-weighted crowd (2 nd graphic) on the outcome of the Republican presidential primaries:

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Funding disintermediated <ul><li>Where VC & angels left off, the crowd has taken over: </li></ul><ul><li> </li></ul><ul><ul><li>GrowVC : seed funding for startups </li></ul></ul><ul><ul><li>Cofundit : non-dilutive debt funding </li></ul></ul><ul><ul><li>Kickstarter : non-ownership funding of creative ideas </li></ul></ul><ul><ul><li>IndieGoGo : perks based collaborative funding </li></ul></ul><ul><ul><li>WiSEED : French language crowd funding </li></ul></ul><ul><ul><li>WebEquity : exchange sweat equity for rev-sharing </li></ul></ul><ul><ul><li>40billion : fund through friends & family loans/gifts </li></ul></ul><ul><ul><li>Profounder : (launching this Fall) </li></ul></ul><ul><ul><li>Investedin : tap social network for p2p lending </li></ul></ul><ul><ul><li>Ibovo : facilitates team & partner building </li></ul></ul><ul><ul><li>Innovatrs : investor briefs sent by open call to entrepreneurs </li></ul></ul><ul><ul><li>YouBeTheVC : crowd votes on 3 startups for VC to fund </li></ul></ul><ul><ul><li>FairSoftware : virtual team works for non-equity upside </li></ul></ul><ul><ul><li>... </li></ul></ul>

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Valuations disintermediated <ul><li>Public valuations have been crowd-sourced since mankind has traded goods, and certainly in capital markets. Excepting some current-day aberrations (High Frequency Trading, extreme leverage, derivatives, etc.), the price discovery of the “invisible hand” of the market has ruled. </li></ul><ul><li>Crowd mechanics can and are being applied to private valuations. The 1st wave has begun: </li></ul><ul><ul><li>YouNoodle : mine thousands of online sources including media, blogs, Twitter, etc. Outcome/valuation prediction. </li></ul></ul><ul><ul><li>SharesPost : an exchange for private company shares. </li></ul></ul><ul><ul><li>SecondMarket : marketplace for illiquid assets. </li></ul></ul><ul><ul><li>Private Equity Exchange : restricted share marketplace. </li></ul></ul>

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Startups are not macro-bound <ul><li>VC is extremely beholden to macro trends: </li></ul><ul><ul><li>6% statutory caps for LPs in an asset class which doesn't re-price quickly; capital calls = bad news. </li></ul></ul><ul><ul><li>IPO windows determine time-to-exit and thus the TVoM impact of VC fees (more expensive now). </li></ul></ul><ul><li> </li></ul><ul><li>Without artificial VC barriers, nimble startups are opportunistic w.r.t. the macro climate (e.g. chase cost savings and efficiency during bad times, refresh cycles during good times). </li></ul><ul><li> </li></ul><ul><li>As the macro climate remains challenging for VC, the window will continue to open for all forms of crowd-funding activities. </li></ul><ul><li>Another major downtrend in the stock market will exacerbate the divergence of crowd vs VC funding. </li></ul>

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Today's crowd-funding model <ul><li>Lots of small-money investments aggregated. </li></ul><ul><li>ROI may be in: </li></ul><ul><ul><li>money </li></ul></ul><ul><ul><li>perks </li></ul></ul><ul><ul><li>produced goods (e.g. DVD) </li></ul></ul><ul><li> Investors may be: </li></ul><ul><ul><li>Accredited investors </li></ul></ul><ul><ul><li>Friends & family </li></ul></ul><ul><ul><li>Anyone in the crowd (generally small amounts) </li></ul></ul><ul><li>Biggest hurdles: </li></ul><ul><ul><li>SEC Regulation D issues in the USA prevent general solicitation & advertising, which is what crowd funding is. </li></ul></ul><ul><ul><li>In some other countries, this is less of an issue. </li></ul></ul>

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Tomorrow's crowd-funding model <ul><li>Crowd-funded will be a much broader paint-brush! It will mean using the crowd for funding, facilitation, diligence, team-building, valuation, etc. </li></ul><ul><li>Heterogenous crowd funding: </li></ul><ul><ul><li>Co-investment of the crowd with VCs/angels. </li></ul></ul><ul><ul><li>Other Private Equity forms (e.g. hedge funds) will directly inject money into crowd-funded startups. </li></ul></ul><ul><ul><li>Publicly traded vehicles will be created with a charter to invest in crowd-funded startups. Imagine these (contrived) tickers: </li></ul></ul><ul><ul><ul><li>IPHN_GAME : ETF of iPhone game startups </li></ul></ul></ul><ul><ul><ul><li>SOCL_NTWK : managed social network startup fund </li></ul></ul></ul><ul><ul><ul><li>SMRT_METR : black-box hedge fund of smart metering </li></ul></ul></ul><ul><ul><ul><li>INDY_DVD : fund of independent movie content </li></ul></ul></ul><ul><ul><ul><li>... </li></ul></ul></ul>

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The ultimate: a public asset class!

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The ultimate: a public asset class! <ul><li>Soon, you'll buy exposure to startups on the public market. </li></ul><ul><li> </li></ul><ul><li>But guess who else will invest in startups as an asset class? It's playtime for Wall Street (new fee & returns oppties!): </li></ul><ul><ul><li>Hedge Funds </li></ul></ul><ul><ul><li>Mutual funds </li></ul></ul><ul><ul><li>ETFs </li></ul></ul><ul><ul><li>Pension funds </li></ul></ul><ul><ul><li>Sovereign wealth funds </li></ul></ul><ul><ul><li>And of course, corporations trying to hedge and/or buy into the future </li></ul></ul><ul><li> </li></ul><ul><li>This will be a 100x or 1000x force-multiplier for crowd-funding! And the rumblings are already happening... </li></ul>

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What will VC look like? <ul><ul><li>The new “lean-and-mean VC”. Minimal fees, they'll live like startups! </li></ul></ul><ul><ul><li>The “virtual VC”, based virtually anywhere, using service providers from the crowd facilities. Their networks moved online. </li></ul></ul><ul><ul><li>Will co-invest with the heterogeneous crowd. </li></ul></ul><ul><ul><li>Winners will be ones which consistently adapt, using the crowd to quickly identify good startups, teams, providers, ... </li></ul></ul><ul><ul><li>Successful ones will embrace rating systems and achieve high ratings early on (high ratings will be tomorrow’s Tier 1). </li></ul></ul><ul><ul><li>Some may even use algorithms: “the black-box VC”. </li></ul></ul><ul><ul><li>Crowd-funding services which offer funding from a crowd-pool will effectively become VCs as well. </li></ul></ul>

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Evolution of crowd-funding Current crowd-funding solutions are serving early phase (concept/seed stage) startup/product creation. But the crowd can do a better job at valuations at any stage, can provide matching of service providers, etc., and ... As crowd-investing becomes heterogeneous (all the sizes of players participate), then... Seed --> Series A --> Series B --> ... Why are there any limits to how far it can grow?

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The battle is not VC vs the Crowd VC will be forced to integrate with the crowd. Anyways, VC is only satisfying a tiny % of startup capital demands. Within the crowd, the battle is human vs. the machine. Will people or machines pick the best crowd startup investments? And which crowd vehicles & services will win? The crowd provides a fertile new ecosystem; a lot of change is occurring and a lot more is coming. Get ready... “ To build a new system you don't compete with the old one, you build a new system that makes the old one obsolete” -Buckminster Fuller

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Now about the SEC… The USA is currently ill positioned to take advantage of the immense growth and innovation machine that the crowd unlocks. One effort to change this recently produced an SEC Petition , now open to comments ( instructions for submitting comments ). The petition was drafted by the Sustainable Economies Law Center and was crowd-funded using IndieGoGo. You can follow that effort on the Change Crowdfunding Law blog (or better yet the mailing list). They’re petitioning for an exemption of securities offerings up to $100,000 with $100 maximum per investor. Now is a great time for the crowd to speak…

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TrendCaller.com Kevin Lawton Author of the book: “ The CrowdFunding Revolution | Social Networking Meets Venture Financing ”