Business

03.03.13

FundersClub Takes Crowdsourcing Approach to Early-Stage Venture Capital

The social, consumer-facing web created by Google, Facebook, Twitter, and hundreds of other companies that sprang up in the Silicon Valley would not exist today if not for the money and expertise of the individual angel investors and venture capital funds. But the venture capital industry itself has barely caught on with the innovations it has created. FundersClub is trying to change that.

“While the VC industry has been supporting innovation for the past 30 years, it hasn’t necessarily itself innovated like the companies it’s supported,” said Alex Mittal, the 28-year-old co-founder of FundersClub, an angel investing platform that has been active since last summer. Mittal, who founded the firm along with Boris Silver, 24, is himself an entrepreneur. The University of Pennsylvania graduate founded Innova Dynamics, a clean-tech engineering company. His latest venture, FundersClub, is attempting to transform venture capital and allow wider access to investments that are usually the purview of rich and well-connected individuals and firms that make up the bulk of Silicon Valley’s smart money.

Here’s how it works: an investing committee for the company screens startups that could be hosted on the platform. FundersClub then hosts a few at a time, allowing accredited investors—individuals with annual income of $200,000 or net worth of $1,000,000—to write relatively small checks (typically between $1,000 and $5,000) to a free-standing fund that then invests in each company. FundersClub doesn’t charge any fees to investors or companies and has not yet disclosed how it plans to make money for itself.

Since launching in late July 2012, FundersClub has raised $1.75 million for six companies on its platform and has attracted $6.5 million in outside funding for itself, including investments from big-name venture capital and angel firms like First Round Capital, Andreessen Horowitz, and Spark Capital.

To a degree, members of the FundersClub are flying blind. Traditional angel investors, like Peter Thiel, who famously made nearly $1 billion on his 2004 investment in Facebook, can get a wealth of financial information and formal influence over the direction of a company they’re investing in through a spot on the board. But the disclosure requirements for companies funded on FundersClub are thin. According to its lengthy FAQ, there are no specific requirements for informing investors: “The companies are not required to provide periodic financial statements (or audits) or other updates.” Also, since there can be up to 95 individual investors in a FundersClub fund, there is no direct oversight or board spot for the FundersClub members.

Darian Ibrahim, a law professor at the University of Wisconsin, who studies venture capital, says, “if FundersClub can aggregate capital and invest in a hands-on way, they might have a better chance of succeeding as an online platform.” He cautions, however, that what makes the U.S. unique in high levels of investment in private companies is precisely what the traditional venture capital and VC model offer: disclosure. “The secret to U.S. venture capital is hands-on monitoring,” Ibrahim says.

But what about the companies themselves? Are there really great businesses that are starved of capital from professional angel investors and venture capital firms? Not really. “For the best companies, money is not really a problem,” Mittal says. The problem for many startups, according to the FundersClub pitch, is making the right connections, getting access to customers, vendors, employees, and the thick web of formal and informal contacts that you find spinning out from every successful startup in the valley.

Soldsie was able to bring on an engineer who was the designer of Facebook’s applications platform as the company’s chief scientist. Where did it find her? She was a FundersClub investor who was part of the $425,000 funding round for Soldsie.

Mittal points to Soldsie, an e-commerce company that operates within Facebook, which was short-staffed as its monthly revenue volume rose from five to seven figures. The company needed talent and needed it fast. Soldsie was able to bring on an engineer who was the designer of Facebook’s applications platform as the company’s chief scientist. Where did it find her? She was a FundersClub investor who was part of the $425,000 funding round for Soldsie.

FundersClub so far has hosted only companies that have come out of the startup accelerators 500 Startups and Y Combinator (FundersClub itself is a Y Combinator alumnus). With these stamps of approval, FundersClub claims that it gives the investors access to companies that they would otherwise need a big checkbook or the right connections to be able to invest in at all. “Knowing what to invest in, getting access, writing check sizes small enough to diversify previously have been extremely difficult,” says Mittal, “we have changed the circumstances so people can get access to those types of startup opportunities.”

The smaller checks and access to the more viable companies are crucial to FundersClub’s pitch to investors, because the only way angels and venture firms can make significant profits is by getting access to the best entrepreneurs and by making a lot of investments. “[Angel investing] is doing well for angels who diversify. For angels who invest in five or more companies, they start to see very good returns,” Mittal says.

But those returns are concentrated with a few firms and angels. Research by the Kauffman Foundation found that over 25 years only 20 percent of the 100 firms they studied “beat a public-market equivalent by more than 3 percent annually.”

“I don’t think people should make angel investments, full stop. I think it’s a losing game for all but a very few who have access to the very best entrepreneurs. No website helps address that problem,” says Andy Rachleff, CEO of Wealthfront, a software-based financial adviser. Rachleff, who teaches at Stanford’s Graduate School of Business and was a founding partner of Benchmark Capital, is a prominent skeptic of angel investing. He argued in a TechCrunch post that “premier venture firms succeed because they have proprietary knowledge of the characteristics of winning companies,” and “unless you can have the pick of the best technical founders in the valley or you are a member of the PayPal mafia, you should not be an angel investor.”

Rachleff doubts that FundersClub allows for the type of diversification that Mittal and other angel investing optimists say is necessary. “You can take a portfolio approach to crap, that doesn’t help. The only value a third party can add is access. Can you provide proprietary access to quality? If the answer is yes, then that’s a tremendous service. If the answer is no, then it’s not worth it.”

While FundersClub, which was has been up and running only since late July, can’t point to a successful acquisition or IPO of one of its portfolio companies yet, it can point to the money it has raised for other companies ($1.5 million), the money those companies have raised in total ($16.5 million), and the 5,000 investors on the platform. It also managed to raise a hefty hunk of change for itself on the platform, some $463,801 from 85 investors. “It’s not even theoretical. We were our first investment … in an eat-your-own-dog-food type of way” Mittal says. Investors are hoping some of that dog food turns into Kobe beef.