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Thursday, August 2, 2012

Is crowdfundig a threat to VC firms?

With so much talk of crowdfunding in the air we probably need to start asking the question on whether crowdfunding will be asking over from VC firms in providing the much needed business finance for the 1000's of startups needing seed money and not finding it anywhere at the moment.

Recently, Fred Wilson, a famous VC at Union Square Ventures, proffered a rather pessimistic assessment of the future of his industry in the wake of the JOBS Act and the resulting move to equity crowdfunding. Wilson sees great potential for entrepreneurs using crowdfunding portals to raise capital. But for the problematic VC industry, the news isn’t so good. His thesis is that it’s better right now to be an entrepreneur than to be a VC. In his own words, “Venture capital is becoming a bad business.”

In his estimation, Wilson sees families investing one percent of their assets in crowdfunding, which translates to a $300 billion bonanza for entrepreneurs and start-up companies. This process could start by the end of this year, when the first equity crowdfunding portals will go live. We are all waiting for the Securities and Exchange Commission to finish making rules, which are due by year’s end. Wilson isn’t particularly sanguine about the returns on these investments, but he doesn’t discount the lottery mentality that will probably drive crowdfunding investing despite the risks.

Currently, VC firms receive about $30 billion a year in investments from large institutions and banks. This is only about four percent of the investors’ portfolios, which may reflect the fact that the VC market has underperformed the stock market in the past two decades. Apparently, about $15 billion of that annual investment goes up the chimney because of bad investments. In other words, the best VCs can do is put $15 billion to productive use each year. This begs the question – who will figure out how to intelligently employ $300 billion in crowdfunding investments?

A company can only raise $1 million per year via crowdfunding. For VCs and angel investors, this is chump change. Angel investors regularly invest much larger sums – in recent years, Russian, Middle Eastern and other angel investor have sweetened the VC pot $1 to $2 billion annually. How will $300 billion in crowdfunding “casino money” be allocated to so many small businesses without overwhelming the system? Wilson doesn’t have the answer, but he does have a recommendation to VCs – become entrepreneurs or, if you can believe it, bloggers! While crowdfund blogging is the most noble of professions (ahem), it’s more likely that VCs will simply adapt to the new environment. Wilson offers five options:VV 1. Make investments in obscure niches rather than following the crowd.
2. Cut by an order of magnitude the amount of money you raise.
3. Become angel investors.
4. Become leaders in the crowdfunding industry by making recommendations of companies they think are worth funding.
5. Retire.