Posted: Feb 08, 2012 12:01 AM

One of the latest trends in financing for start ups is crowd funding. Various websites are trying to tap into the social media craze by establishing a social funding network for a start up company. While I appreciate the sentiment, I am not sure that’s the best way for founder’s to raise capital for the long term viability of their company. As with most things, it depends.

What’s it depend on?

Well, if you have zero resources, no friends or family with any sort of expendable money for you to try and build a business out of, then I get using crowd funding to get capital for a “Friends and Family” round. You can only take a business so far without capital. Many businesses these days are based on a freemium model, so getting cash flow through the company initially is difficult.

However, if you are a startup and just want to take a check from an investor and run with it, you are making a mistake. Founders, it’s not just about the money. It’s also about mentorship. How many times have I seen companies with good ideas go broke because of issues besides money? Quite a bit.

More often than not, a founder has good command of the initial market they are trying to attack. But, more often than not, they don’t know a lot about running a company once they get a big capital infusion. It can be intimidating. Lack of confidence can doom the company because it infects the culture. You begin to second guess yourself. Without a good mentor, you can be doomed before you start.

Crowd funding works fantastically for certain things. There is a Chicago start up called Give Forward that takes the concept of crowd funding and applies it to people that are sick and need money for operations. It’s a great idea. The company is doing well from what I understand.

But, to carry crowd funding to all start ups is a different matter.

Currently, the bill is stuck in the Senate. It will stay stuck there for a little bit while they iron out the kinks.

There are various problems. One is that you might get mercenaries that will prey on unwitting people. No one wants that. Yesterday’s snake oil salesman might be today’s traveling venture capitalist. Certainly, no one in the industry wants that, since they have worked hard to get decent reputations. The last thing they need is Snidely Whiplash ripping off Grandma.

The other problem is that accredited investors are only allowed by the government to invest. Dodd-Frank made the bar a little higher to become an accredited investor. That limits people’s freedom. They ought to be able to make up their own mind about what to do with their own money. Limiting the amount of accredited investors makes angel investing more like an exclusive club. Based on the founding principles of America, it shouldn’t be. Anyone ought to be able to invest in a good idea and earn a return from it.

No doubt, crowd funding is a huge megatrend in financing. But I think once people realize all the nuts and bolts that go with funding start ups, the trend will abate. For entrepreneurs, they need to be very careful who they accept money from. They only have a limited supply of equity. They need to make sure the people that buy that equity from them can help them grow the value of it. I am not sure that will happen with crowd funding.

Trending Townhall Video