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Oculus Facebook deal will accelerate equity Crowdfunding and change the world. March 30, 2014

Posted by Bernard Lunn in capital markets, start-ups.
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3 comments

The Oculus founders got $2.4m of free seed funding via Kickstarter. Let’s say that had been a traditional Angel or Seed VC equity round for 25% of the company. Those seed funders would have got, in aggregate, 25% of the $2bn that Facebook paid, which is a substantial $500m.

I believe that the Oculus Facebook deal will accelerate the equity Crowdfunding revolution. Yes, this is good news for the future, even if a lot of people who gave free funding to Oculus via Kickstarter in return for a beta product and a T Shirt feel a bit burned today.

FWIW, the terms were clear, the folks who ponied up cash were promised an early version of the product and got what “it said on the tin”. As Matt Asay points out on ReadWrite, this is the same issue as people who contribute to open source and watch an entrepreneur get rich.

Personally I think how millions of people make a living as we emerge out of the Great Recession – the crowdfunding story – is more interesting than how a bunch of overstimulated people ramp up the stimulation to the max on the dial – the VR Oculus story. Page views – the currency of the Internet – will undoubtedly prove me wrong.

Tales of an early stage/seed funding bubble get a wry laugh outside Silicon Valley. The Oculus story is also about a “unicorn” ($1 billion plus exit) spotted outside the Valley. Unicorns are rare enough, but Unicorns outside the Valley leads one to refer to Skype – and who else? Well now it is Skype and Oculus. Oculus is from Southern California, which might as well be Ulan Bator (capital of Mongolia) to the Sand Hill Road VCs. If Oculus had been in the Valley they would have easily got Angel funding – and given 25% to those Angels.

Hmm, being outside the Valley is better, you just get free equity financing via Kickstarter?

Not so fast, this is the last deal like this. Nobody wants a bunch of T Shirts plus being the first kid on the block with a new toy for $500m of equity value.

Kickstarter, which was born in New York, is an unexploded bomb on the tree-lined streets of Sand Hill Road. The economic impact of Crowdfunding will be felt outside the Valley. It is a simple need issue. Crowdfunding is much less needed in the Valley compared to Europe, Asia and other parts of the world that have so far been less impacted by the digital revolution. Or compared to LA or New York or New Jersey or (a few other places in America where most people live).

However we are still in the really, really early days of crowdfunding, the days when we have not yet moved from the “first they laugh at you” phase. There are also different forms of crowdfunding. As an adviser to startups, I recently had conversations with two entrepreneurs both of whom were looking at Crowdfunding as a way to get their dreams realized:

1. Niche electronic product, using Arduino. The entrepreneur lives in UK and has no access to the VC world.

2. SaaS product. The entrepreneur lives in New Jersey, close enough to some good VCs. The bigger problem is that he is older than is considered optimal by VC. Of course no VC would reject him for that reason, other reasons would be given (as this article on ageism in the Valley describes so vividly).

The old joke from the early days of the Internet – “on the Internet, nobody knows you are a dog” – has a new life for entrepreneurs who are not young white males living in the Valley. Crowdfunding means that nobody knows that you are old, female, colored or live in the middle of nowhere when you are seeking funding. You can pay a friend to star in the Kickstarter demo video.

The fact that Kickstarter is now in the UK is a big deal, a sign that this is a global revolution, but it is only a start, we need to see this in every remote corner of the globe. An entrepreneur in Africa (where mobile money disruption is happening for real) should be able to tap into both local and global markets using these networks.

This has revolutionary implications for the VC business. The cost of building the first MVP has already plummeted to the extent that, in many cases, no external funding beyond Friends & Family is needed. The Angel/Seed VC round is now needed to fund the go to market phase. If Crowdfunding takes an axe to those go to market costs, the balance of power between talent and capital will shift dramatically.

The SAAS entrepreneur does not need funding to develop the product, he has built it on his own time. He is looking at crowdfunding as part of his go to market strategy, by selling equity at a bargain basement price to early adopters in his niche who will give him good feedback and evangelize the product after launch. Selling Equity is not part of a capital raising strategy, it is part of his go to market strategy. After the Oculus Facebook deal, this could become the norm. Peter Lynch, a legendary investor who is up there with Warren Buffet, advised investors to invest in what they knew (check out the company that makes a product that you and your friends love). The gaming enthusisasts who backed Oculus on Kickstarter knew what was good well before the VCs who made money by watching them. Many VCs today are like an A&R guy watching the audience for a hot new band and recording the enthusiasm on his clapometer – “the kids seem to like these Beatles”.

These days, retail investors have to wait until the easy money has been made by VC, in order to invest at IPO time. Yet these are the people who spot the brilliant new products well before the VCs do.

This brings our attention to which Crowdfunding networks will win and how will they evolve? I tend to think of Kickstarter and IndieGoGo when I think of Crowdfunding. That will annoy all those building other networks, but this is a classic winner takes all network effects market. I can envisage two maybe three networks in ten years time, but I cannot envisage 5, let alone 10 or more. The winning networks will have to scale to cover all the Four Crowdfunding options which are:

1. PreOrder Plus Reward. This is how Kickstarter and IndieGoGo work today. This is how Oculus got funded via Kickstarter. This is relatively easy from a regulatory POV as it is about e-commerce rather than financial markets, so this is easy to globalise.

2. Equity. This is where regulatory complexity arrives (for good reason, this is where scam artists will operate). Even if the primary use is PreOrder Plus Reward, you may still want to offer Equity and it makes the process dramatically easier if this is done on a single platform. The JOBS Act in America leads the way. Even though other countries pioneered this, most countries will take the lead from America or miss out on the wealth/job creation from innovation. I think that networks that combine PreOrder Plus Reward with Equity will win out over pure Equity funding platforms such as Angel List. This is where the Oculus Facebook deal changes the game. The funders of a future product will expect equity in addition to beta product and T Shirt.

3. Debt. Why add this to Crowdfunding networks when perfectly good Peer Lending networks already exist? The reason is that the loan is done within context of the product being built/launched, there is less collateral or cash flow but the lender might still be motivated to lend because they know the entrepreneur and/or share the passion. In some cases equity will be appropriate (it’s a big market and there will be an exit) and in other cases debt will be appropriate (it’s a niche market and a big exit is unlikely).

4. Donation. Some wealthy investors may prefer to donate (and circumstances permitting, get a tax write off).

Crowdfunding networks will have to be big to do all four on a global scale, but the opportunity is massive.

Many VCs want to believe that the entrepreneurs who use Crowdfunding to get started will need them when they want to scale. It certainly worked that way in the case of Oculus. I am not sure that will be true in future. Crowdfunding naturally works in markets that are not capital intensive. The VCs don’t want to stuck investing in capital intensive businesses (like renewable energy, new healthcare drugs & devices, the kinds of products that take serious R&D $$$ before a launch is feasible). Other sources of funding such as Hedge Funds can jump in when they see momentum at a later stage.