It is abundantly clear that not enough capital is flowing through the ecosystem to fund the many great startup companies that desperately need it to succeed.
This represents an enormous challenge for Canada in its effort to cultivate its knowledge based economy. Often, venture capital funds and angel investors struggle to close funding rounds because there are simply not enough professional investors in this sector to gather enough resources. Ironically, there are many individuals who want to invest in startups, but lack the essential combination of network, expertise, and net worth to do so effectively.
So how do we address this problem and close the so-called “funding gap?”
Let’s first clarify which funding gap we are talking about as this is a hot topic. A quick scan of Techvibes for “funding gap” reveals some interesting results. An article about a shared tech office space in Montreal, one about a new Alberta $10 million government co-investment fund, and one about a SR/ED debt financing fund in Cambridge, Ontario, amongst others. To call this problem “the” funding gap requires definition as “a” funding gap exists whenever less funds are available than required, which is a prevalent issue indeed.
The funding gap referred to in the first paragraph is the one that finds early-stage companies who have successfully raised less than $1 million in capital from friends, family and angel investors currently looking for a more significant influx of funds to scale and accelerate their growth.
It is popular to think that crowdfunding is the answer to this problem, but is it? A well-crafted crowdfunding campaign certainly can provide additional capital at any stage of growth for a startup. However, if the goal is to execute a plan to reach scale and an eventual exit, then crowdfunding may not be an appropriate solution as it is impossible to predict how much will be raised and within what timeframe.
There is also a significant risk that not meeting the stated funding goal could leave the startup exposed to something akin to “broken IPO” syndrome where the message to the market is essentially: “people don’t like us nearly as much as we thought they would.”
This has historically proven to be detrimental for public market companies and is a difficult perception to overcome. But broken IPO syndrome is just one of the potential challenges that a crowdfunded startup could face. The whole premise of crowdfunding is to raise funds from many sources.
Let’s assume a startup executes a flawless campaign and raises capital from dozens of different sources to fund its specific gap allowing it to execute its plan to begin to reach scale. Fast forward to its next funding milestone, which will likely have to come from a VC for funding size reasons alone. From the VC’s perspective, this company (albeit ready to scale) is both a difficult financial instrument to navigate through due to its large number of different investors and is a difficult business to manage through to a successful exit.
With all that said, the jury is still out on crowdfunding being a good option for investors who want exposure to early stage companies. Ignoring the very obvious risks associated with investing in random, private companies with zero track record, and no real regulatory requirements, how can an investor really know if a startup is worthwhile by watching a two-minute video and reading the company’s profile?
Okay, so if the answer isn’t crowdfunding, then what is it? How can a company access the capital of passive investors in a way that doesn’t open themselves up to other issues? At the same time, how can passive investors put growth capital into the hands of entrepreneurs in a structured way that mitigates much of their risk?
Those are the $10 million questions, and if they don’t reveal what the true funding gap is, then they certainly reveal the real reason why the funding gap referred to in this article exists.
A potential solution lies in both an obvious and unlikely place. VCs are best equipped to analyze companies, build a portfolio, diversify risk, use their expertise to help the companies grow as fast as possible, and subsequently find the most lucrative exit opportunities. The problem is that no VC will give an investor the time of day unless they have $1- to $2-million to invest in their fund on day one.
One VC said recently that “it would take me 200 times the effort to deal with one retail investor putting in $200,000 into my fund than it would an institutional investor putting in $2 million.”
There is a clear opportunity for someone to take on this 200-times-effort challenge and provide the structure and professional management that the vast pool of individual investment dollars is crying out for. It could very well be the bridge across this particular funding gap that our ecosystem has been searching for.