Crowdfunding Shakes Off Its Stigma

by Eric P. Newcomer

In the clubby world of venture capital, crowdfunding is stepping into a leading role. The latest proof comes Tuesday when dozens of young startups are pitching themselves to investors at Y Combinator’s twice-a-year “Demo Day.”

At least nine of the current group of 53 plan to use crowdfunding, which allows certain people to invest in a company in exchange for  equity. That’s according to crowdfunding services WeFunder and AngelList. (They declined to specify which companies have signed up.) This comes as many are still firming up their plans and soliciting investors, who are attending Tuesday’s event in droves.

We spoke to 30 YC-backed companies that pitched investors during the last Demo Day in March and some crowdsourcing firms they worked with. We found that at least 12 companies used crowdfunding. They include Teespring, which makes custom T-shirts, and Goldbely, which sells gourmet food online.

Jessica Livingston, a partner at Y Combinator, an eight-year-old “incubator” for startups that helps them shape their ideas and products in exchange for an equity stake, says the firm doesn’t have complete data on the number of companies in its program that use crowdfunding. Nonetheless, she said that more companies are using it.

The number of crowdfunding services that allow startups to tap investments from random individuals who meet certain investment criteria, as opposed to just traditional venture capitalists, has been growing quickly. They include CircleUp, which lets users invest in consumer-goods companies like vitamin retailers, and MicroVentures, which brokers deals between individual investors and early-stage tech startups.

But in many ways, they have  remained on the fringes of the investing world. Some startups have been reluctant to use them, preferring the prestige of established investors. Others have worried that doing so would suggest they couldn’t raise funds from blue-chip venture capitalists.

Tuesday’s Demo Day provides a window into how those attitudes are changing. The event is closely watched as a bellwether for new categories of startups, valuations and investing patterns.

Among the companies planning to use crowdfunding this round is 7 Cups of Tea, a company that lets people talk to others for emotional support online.

Glen Moriarty, founder and CEO of 7 Cups of Tea, said they plan to raise some money through crowdfunding, which will also help generate publicity. They are doing so through WeFunder, a crowdfunding site that showcases companies it works with to investors on its website.

Moriarty said the company hasn’t yet decided how much it wants to raise through WeFunder.

The number of services that allow startups to raise equity from individuals has grown steadily, as have the dollars invested through them. In 2010, users invested $49.9 million on equity crowdfunding sites. By 2012, that number grew to $115.7 million and will be $165.9 million by the end of 2013, according to research firm Massolution.

WeFunder, which launched earlier this year and is backed by Y Combinator, believes that its user base will grow dramatically after new Security and Exchange Commission rules let crowdfunding sites publicly advertise startups that are raising money and recruit less wealthy investors.

These new rules could upend how startups raise money, helping fledgling companies raise money from less monied investors across the country and far outside the Silicon Valley bubble.

Zenefits founder Parker Conrad says his company gave crowdfunding a shot after participating in Y Combinator’s program earlier this year. The online-benefits provider raised $50,000 on WeFunder, 2.4% of the total $2.1 million it raised.

Even though they recognize that crowdfunding sites are competing with venture capitalists to raise money for startups, some VCs don’t sound too worried about the emerging source of competition.

Aydin Senkut of Felicis Ventures said sought-after companies seek investors with specific expertise and that won’t change. “I welcome the diversity,” he says.

Here’s our breakdown from the group that raised funding this spring:

Used crowdfunding Skipped crowdfunding
CircuitLab (FundersClub) Airware
Goldbely (FundersClub & WeFunder) Beatdeck
Medisas (FundersClub) Bitnami
Meldium (FundersClub) BuildZoom
Thalmic Labs (FundersClub) CrowdMed
Padlet (FundersClub) Errplane
Prizeo (FundersClub) Fivetran
Screenhero (FundersClub) FlightCar
Strikingly (FundersClub) Heap
Teespring (FundersClub) Lawdingo
WeFunder (WeFunder) Lollipuff
Zenefits (WeFunder) Microryza

Source: The companies, FundersClub and WeFunder