March 24, 2013
True entrepreneurs don’t just have a business idea, execute it, and then move into a cushy corner office. They must continue to innovate and come up with new plans to disrupt a market. Investors need to start considering what they are backing — the idea or the individual. The entrepreneur worth investing in has passion that won’t die out, but he or she is also focused enough to follow through with the project.
Crowdfunding: The New Founder’s Key to Success
Crowdfunding, the concept of pooling resources from a variety of individuals who want to invest in a company, has seen success on platforms like Kickstarter (think Pebble). Crowdfunding is a mix between pursuing venture capital and acquiring shares of a company on the open market. This practice will become more and more common in the future since it received some legal status as part of the recent JOBS Act that Congress passed in 2012.
“Contrary to rumors circulated by some in the popular press, crowd-fund investing is unlikely to replace existing early-stage funding channels like angel investors or venture capitalists,” wrote Jason Best and Sherwood Neiss of Crowdfund Capital Advisors. “Rather, it will expand upon capitalization alternatives and compliment other funding mechanisms.”
While crowdfunding may make it easier to raise capital for a project, it doesn’t necessarily make it easier for the project to succeed. As the popularity of crowdfunding grows, new models taking shape may change the traditional idea of what investing in a startup means.
Back the Person, Not the Company
Companies like Upstart are working to invest in entrepreneurs — or individuals who have the potential to become successful entrepreneurs — rather than the startup itself. Investors finance students in exchange for a share of their future earnings.
Students build profiles outlining their successes to date and what they hope to achieve in the future. They can then choose to offer up to 7 percent of their yearly income over a 10-year period of time to an investor in order to repay the initial investment. Students can choose to use this money in a variety of ways to achieve their future goals, including building their businesses or paying off student loans. Upstart takes a 3 percent fee from the investor funds the student receives, and then takes 1.5 percent of what the student pays back.
If students are exceptionally confident in their future income and exceptionally broke, Upstart may help. But students should consider the long-term effects of taking a loan based on their personal potential, instead of the potential of a specific company/business concept. Many students at this stage are only focused on the now; they are not prepared, nor do they have the knowledge to understand if and how this will help or hurt their future financial and business successes.
Is This the Future of Student Loans?
Upstart allows investors to finance promising students in exchange for a percentage of their income, but the specifics of the model just aren’t there yet. The devil is in the details. In other words, there just isn’t enough of a guarantee that a student (the investment) will even have a job…much less a job that pays a reasonable salary. The hope is to give investors a 6 percent annual return.
Another possible drawback of the Upstart model is that today’s generation of college students have commitment issues. They may not be prepared to commit giving up a portion of their potential income for the next 10 years. In some ways, sites like Upstart may give crowdfunding a bad rap. While conventional crowdfunding is a tool to fund high-growth businesses that would traditionally seek venture capital, Upstart isn’t funding businesses — it’s funding students who may or may not be successful enough to pay the investor back in the future. While many students show early potential, it’s just that: potential.
Overall, this type of crowdfunding is a risky strategy. Students give up potential income for the long-term, and sites like Upstart may be taking advantage of the short-term focus of so many students. Graduating with crowdfunding means having yet another cloud of debt over their heads for up to 10 years. If there is no other way to complete college, then financing their future through crowdfunding may be a viable option. Otherwise, it would be better for students to get part-time jobs and bum money off their families like everyone else.
Dr. Greg Bier is a professor of management at the University of Missouri. He leads the newly formed Entrepreneurship Alliance at the University of Missouri Trulaske College of Business. He is also a partner with Entrepreneur MO (www.mo.com). Follow Greg on Twitter at @gregbier.
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