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Crowdfunding has stormed the startup scene. Many entrepreneurs are turning to platforms like Kickstarter and Indiegogo to raise funds rather than seeking traditional seed capital. Success stories like gaming console Ouya and smartwatch Pebble have sent waves of excitement through a startup community that relies heavily on venture capital to keep its blood (and dollars) flowing.

Most entrepreneurs have faced rejection from investors at one point or another, and crowdfunding provides an alternative to going door-to-door to major VC firms looking for someone who believes in you and your idea. Along with the rise of crowdfunding comes criticism of the VC fundraising model and questions about the future of venture capital.

Is crowdfunding the new seed funding? And how does crowdfunding change the venture capital landscape?

‘Friends-and-family funding on steroids’

Research firm Massolution recently published a report on the state of the crowdfunding industry. The report found that crowdfunding generated 1 million successful campaigns and $2.7 billion across the globe in 2012, which is an 81 percent increase from 2011. People from across the startup spectrum with a range of motivations are using these platforms to circumvent the usual seed-funding process and raise money directly from consumers.

“Companies in their early stages are faced with tougher entry barriers to the private equity markets than anyone else and thus are more likely to be attracted by the prospect of raising capital in a new and innovative way,” said Massolution research director Kevin Berg Kartaszewicz-Grell.

“Internal studies have shown that the success of a crowdfunding campaign is predominantly driven by the support of friends and family — both financial support and support for ‘spreading the word’ about the campaign. Any company that is capable of leveraging social capital will be able to benefit from this form of financing. Crowdfunding is friends-and-family funding on steroids.'”

Crowdfunding for a creative project is an entirely different proposition than trying to get a company off the ground. The term itself has come to encompass projects of all persuasions, including bands trying to finance upcoming albums, teams of experienced hardware engineers building a next-generation storage device, and civic projects that need an extra boost. It has become a complicated and nuanced system that works better for some types of companies than others.

This funding route, from project approval to tentative backers to a zero-sum end result, is not available or appropriate for all early-stage startups, but it’s well-suited to products that are capable of rallying support directly from users. Alon Goren is the CEO of InvestedIn, a company that powers crowdfunding platforms for other organizations. Goren said he was an early-comer to the crowdfunding space and has seen it evolve from a way to fund niche passion projects to a full-blown channel for seed-funding.

“A culture is developing around crowdfunding that is all about collaboration, community, and coming together to make thing happen,” he said.

“Ten years ago, startups wanted to seem as corporate and established as possible. But now people want the personal connection and the story and are excited about the do-it-yourself ethic and maker movement. At the end of the day, the money is the least important part, it’s about building community.”

The hardware revolution

Hardware was formerly an outcast segment of startup society, but the popularity of crowdfunding has helped usher in a hardware revolution. Hardware startups are especially suited to crowdfunding for a few reasons.

People are more likely to put money into projects where they get something tangible in return. The average (non-VC) person is more likely to fund a cool gadget that they want to own than enterprise software or social media marketing tools. Thus it is easier for a hardware startup to attract attention and dollars from mainstream consumers.

And hardware startups generally have higher overhead costs than software startups, which can run on Wi-Fi and Red Bull. Raising money on Kickstarter validates the market by proving  there are people out there willing to buy the product before wasting time, money, and resources producing something no one wants. It also generates preorders and enough capital to take a prototype to market. At that point, traditional investors may begin to show interest.

Jimmy Buchheim is the CEO of SticknFind, a company that makes Bluetooth-powered mini-location stickers so you never lose your stuff. He previously worked for a studio that designed award-winning products for companies like Motorola, Audiobox, Sirius XM Radio, and Microsoft.

“We came up with products and visions behind the scenes and didn’t get any glory at all,” he said in an interview.

“When crowdfunding began to become popular, we saw our chance to get out of the closet and start making things for ourselves. Going the venture capital route is not as easy as it sounds, even if you have a great idea. We are a group of engineers in Florida. We have no contacts or network, and we aren’t marketing guys. We just want to make stuff. Crowdfunding allowed us to move forward as a company.”

StickNFind raised $931,000 on Indiegogo (the goal was $70,000), and Buchheim said he wants to crowdfund all of his company’s future products. As someone with extensive experience developing, manufacturing, and distributing hardware products, Buchheim said he’s confident  the team can meet demand. The capability and expertise to execute on an idea is key here, since crowdfunding platforms are meant to jumpstart products rather than businesses.

But crowdfunding sites are not platforms for sales; and once a campaign closes, entrepreneurs are independently responsible for follow-through. Many struggle to carry out their promises.

Jim Clark is a designer and entrepreneur who launched a Kickstarter campaign for a line of GoPro cases and accessories. The campaign was successful, but the challenges that followed extended far beyond money. Underestimating the time and resources it takes to bring a product to market is one of the reasons why 75 percent of Kickstarter projects are shipped late. After his experience, Clark “broke up” with Kickstarter.  

“In order to manufacture and distribute your product, you end up beholden to suppliers, manufacturers, and everyone else along your supply chain, as well as investors,” Clark said.

“With Kickstarter, your funders aren’t given any information about how hard it really is to pull off the successful delivery of your product. They’re continually reminding you of what they want and need, and you’re scrambling to assuage their fears. Kickstarter doesn’t provide you with any resources beyond your initial funding. If you get into trouble later, you’re on your own.”

Enter the VCs.