As VC’s Pull Back from Funding Startups, Crowdfunding is Poised to Jump in

The Kauffman Foundation for Entrepreneurship hit the nail on the head. “Startups aren’t everything when it comes to job growth.  They’re the only thing.” Other than a good idea, the most critical thing to launching job-producing businesses is capital. Historically, capital to fund the nation’s job creators came from Angels, Private Equity and Venture Capital.  But a new downward financing trend is emerging and the results are potentially devastating.

According to the Silicon Valley Watcher, “the latest report on trends in US Venture investments shows a massive decline of 40% in seed investments in US startups in the final quarter of 2011, and a much larger drop of 48% for the entire year.”

While there was an overall decline in funding across software, Internet and IT services, by far the largest drop was in seed funding for startups, which almost halved in 2011.

As traditional VC firms have moved into later stage funding, Angels and Private Equity have moved into the space they once occupied.  The result is a larger void at the Seed Capital stage.  Without capital to fund startups, the outlook for the nation’s entrepreneurs is grim.

“Capital is necessary to fund innovation, which leads to businesses that create jobs.  Without capital there will be no jobs,” says Sherwood Neiss,  entrepreneur and Chief Advocate for the Startup Exemption, (the group that brought equity-based crowdfunding (aka Crowdfund Investing) to Washington).  So just like any good entrepreneur that identifies a problem, they come with a solution “If we allow the average American to step in and crowdfund the ideas they deem worthy, then we can get capital flowing.”

The idea has merit.  Donation-based crowdfunding has shown that winning ideas can secure adequate seed financing.  Two examples stick out.  On Kickstarter 13,512 people donated almost $1M to two entrepreneurs to develop the Nano Watch.  They now employee 10 people and believe that TikTok has led to an additional 45 support related jobs for the company.  In the UK, The Rushmore Group, raised  £1M from 143 Investors on a Crowdfund Investing platform.  The expansion capital will create over 30 full time jobs, many more part-time jobs and additional support jobs.  “These two examples,” Neiss says, “show the power that crowdfunding can have in creating jobs.  Crowdfunding is much akin to community financing where an entrepreneur will pitch his idea to his or her social network.  Provided that the idea has merit, the entrepreneur is seen as trustworthy, the business model makes sense and the investment opportunity is worthwhile, people will invest.”

Back to the Kauffman study.  A major finding is that start-up firms (those younger than one year old) create an average of 3 million jobs annually, while existing firms lose 1 million jobs each year.  This is predicated upon capital available.  If Congress legalizes Crowdfund Investing, with the departure of VCs from the startup space, the future of seed and expansion capital stands to look like the chart to the right.  With countries like UK leading the pack, it is just a matter of time before the US follows suit.  That or we risk seeing our economy decline as entrepreneurship and innovate fall victim to the Valley of Death.