Since the growing popularity of crowdfunding has gone mainstream, the debate about where crowdfunding falls into a startup life cycle continues.

There has been discussions that crowdfunding may replace the need for VC’s as it’s market cap continues to grow. On the other side, there has also been backfire from VC’s and the prediction that crowdfunding is a fad altogether.

However, crowdfunding is not a fad, nor will it ever replace venture capitalists. They are completely different forms of funding and most importantly, serve as different stages in a startup’s life cycle.

For crowdfunding projects, most are raising money on an initial idea. Project creators have established an idea or product, found a market, and now are seeking to build a community behind their product. Once they have successfully funded their project, they now must deliver their product in the time they allotted, and continue to build their loyal community behind their product.

Why Crowdfunding Can Supplant Seed Funding, Not Venture Capital

Typically, when a startup seeks funding through venture capital, they already have a viable product [or very promising one]. The missing piece to their continued compounded growth is that they lack they funds to keep pushing forward. In exchange for a small piece of equity, they will seek out a VC for an additional injection of cash.

Furthermore, a seed round can put a project creator way in over his head. Just look at the amount of projects that deliver far past their delivery date. To prevent this, a VC will be able to offer insight, connections, and help them manage their product through times when things can get really tough.

 Crowdfunding will not replace venture capital funding, it will become a much better seed round.

The advantage that crowdfunding has on a traditional seed round is that you have the opportunity for validation and community. After you have reached the necessary steps in order to become approved by a crowdfunding platform, you can now seek validation of your idea amongst the community of backers. If you can reach your goal with roughly 500 backers, you have validated your idea. Fortuitously, you also have the foundation for your community.

Trace Sets the Example

I wrote an earlier post about TRACE, who is now seeking a much larger round on Angel List. Back in October, TRACE raised just over $160,000 from 1,100 backers on Kickstarter. After they took their product from idea to production, they turned to crowdfunding for validation and community. They gained a loyal community of extreme sports enthusiasts and are now looking to raise an additional 1 million dollars for 16.67% of the company, putting them at a 6 million valuation.

Instead of raising a seed round via angel investors or friends and family, they raised their seed round on Kickstarter. Now that they have their validation and loyal community, they need a large injection of cash from a VC firm to help them get on GoPro’s radar. Their investors include Ted Serbinski of Detroit Venture Partners and Sami Inkien, founder of Trulia.

Predicting Where Equity Crowdfunding Will Fall

Now where does equity crowdfunding fit this timeline? That has yet to be determined. But ultimately I still do not believe it will come anywhere close to replacing venture capital. It will only add another form of a seed round.

There will be a part of the crowdfunding community that enjoys using their money to invest in a small piece of a company. People will initially see value in getting an ROI. On the flip side, there will be still be a community that supports projects using reward based systems because the ROI on equity side will be a long one and delivering a product is going to be much quicker.

Crowdfunding as a reward based system has plenty of value in terms of funding, but will never replace VC funding. While equity crowdfunding is still unpredictable, my guess is it will serve as another option in seed money. Either way, it’s going to be the wild west.

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