This article was originally published by PandoDaily at http://pandodaily.com/2012/07/06/crowdfunding-streamlines-the-friends-and-family-round/.
Crowdfunding is disrupting all aspects of the startup fundraising ecosystem, from seed rounds all the way up to full Series A rounds. But the ecosystem most ripe for disruption doesn’t involve professional investors at all — it’s the friends and family round — and it’s the true lifeblood of startups.
According to the Angel Capital Education Foundation, startups annually raise $60 billion through friends and family. Compare that to what venture capitalists invest per year ($20 billion) and professional angels ($20 billion), and you’ve got the largest single source of startup capital. Although raising from friends and family is the most likely source of capital, it also happens to be the hardest to extract checks from since there is so much friction when it comes to raising from lots of people.
In this case, crowdfunding is really just mechanizing the process of collecting money from a large group of people. But if you’re an entrepreneur like me, and have raised money from lots of people at the same time, you’ll quickly agree that this is a nightmare. The popular metaphor of herding cats doesn’t begin to explain how laborious this process is.
Big Friction in Small Checks
The only thing harder than raising large sums of capital is trying to raise really small sums. The inherent friction in asking lots of people for money prevents most people from asking to begin with.
Imagine calling a friend to ask for a small check — “Hey Matt, I’m thinking about starting a new company and could really use $25. You’re interested? Great, now can you read me off your credit card number?” Not going to happen. Instead, sending an email that points to your crowdfunding profile makes it easy for people to use any number of payment methods in any amount they feel comfortable with. This, in turn, makes it more likely that you’ll reach out to more people than you would through traditional methods.
Extending to Fans
The small check model also works incredibly well for those that might not quite be friends or family but are fans of what the startup is doing. In many cases these could be potential customers who are willing to make a small bet that a startup will succeed at producing the product.
The concept of pre-selling potential customers is powerful in and of itself since it allows startups to raise money directly from customers for products that aren’t even produced yet. Once again, the friction of raising money $50 at a time for a startup would prevent most entrepreneurs from even trying, but the crowdfunding model easily radiates out to strong affinity groups that can provide another bucket of capital.
Avoiding the Uncomfortable “No”
The worst part about asking others for money is asking at all. It gets progressively more uncomfortable depending on how you interact, with face-to-face meetings and phone calls being at the top of the “most uncomfortable” list. By comparison, asking for contributions through email is relatively easy. The importance of email cannot be understated. Aside from the efficiency of contacting large numbers of people simultaneously, it affords the receiving party a friendly way to pass.
This method was actually pioneered in the early days of online charity fundraising. These days you can’t make it a year without getting someone’s request to support their Pelotonia ride or a Race for the Cure. The online ask is a game changer.
Visibility Adds Value
Moving the funding activity to a public forum also creates visibility on progress. This is critical for generating momentum and social proof. Backers want to support startups with momentum, but they need to know that others are contributing as well.
We watched this first hand at Fundable last month when we had our first successfully funded project, the Elevation Training Mask. The founder worked hard to get his friends and fans to get the initial fundraise about 50 percent of its $10,000 goal. He was able to do that within the first 24 hours, which led others to quickly pile on board and surpass his goal in just 72 hours. The value of demonstrating success publicly (and virally) is incredibly powerful.
Exposing the participation of backers in real time significantly helps the startup publicize and rally around a specific goal. It’s especially helpful when lots of people need to contribute toward the same end game at the same time.
It Adds Up
Efficiently soliciting small sums of money is a big deal. When you think about how much capital is essentially locked away from startups simply due to the inefficiency of aggregating the checks, you realize how much untapped potential exists. Considering over 90 percent of startups never receive funding from professional angel or venture capital investors, a highly scalable and available new source of funding could be a huge win for a lot of entrepreneurs.