Jared Friedman, YC Partner, on raising money online.

We often get questions by startups at YC whether they should look to raise funding on AngelList, FundersClub, Wefunder and other “crowdfunding” sites. These sites have evolved –and continue to do so at a rapid pace. Though fundraising websites like AngelList, FundersClub and Wefunder are legitimate options for startups to raise money, it is important to understand them well before signing on to use them. This post summarizes the evolution of this way to raise funds and provides perspective on their pros and cons.

The History

AngelList and FundersClub were the first websites to popularize raising money online for startups. AngelList’s original model was similar to Kickstarter: companies would promote themselves or their product on the site and investors would join and invest in the ones that appealed to them. AngelList made money from taking a percentage of a company’s equity in return for listing the deal.

AngelList swiftly evolved, improving their model by launching “syndicates.” A syndicate is a group of people that invest money in a company. Each AngelList syndicate has a “lead” investor that invests a certain amount of money and then reaches out to other investors to co-invest. This lead investor is generally well-respected in the industry and others would choose to co-invest and back a syndicate based on the reputation of the “lead” investor. In return, the syndicate lead amplifies their personal investment and receives a percentage of the return on the additional capital raised.

Syndicates proved to be a better model, but still had one big problem. A syndicate couldn’t guarantee that others will invest behind it. This means that the company would not know how much money it could raise through a AngelList syndicate—and, if it had the option, typically would choose to be funded by a venture firm that can guarantee a set amount.

To address this problem, AngelList further evolved its model and released another product called a “fund”. FundersClub and Wefunder also have a similar “fund” model. With a fund, investors sign up to back a particular syndicate lead without knowing anything about the specific deals they are investing in. The fund lead, thus, is granted the discretion to invest a guaranteed amount of money in startups. The benefit is that the fund lead can now guarantee funding upfront and directly compete with traditional seed firms.

The Fund model underscores two important trends in online fundraising:

1. Institutional capital. Initially, AngelList was a true peer-to-peer platform, funded by thousands of individuals investing small amounts. Last year, though, it raised over $400M from two large institutional investors, and likely will raise more institutional capital in the future. Currently, institutional investors account for more than 50% of the dollars invested from AngelList. FundersClub is attracting a high percentage of institutional capital, too.

2. Private, rather than public, investment. In its original iteration, AngelList would enable companies to publicize their campaigns to the public to drive more interest. But when a fundraising round is public on the internet there are drawbacks – particularly when a fundraise does not go well. As a result, AngelList recently announced that it is going to move to all private fundraises.

The future AngelList model may look more like traditional venture capital, but with the VCs working part-time. Syndicate leads could operate as part-time VCs, run their own startups, invest dollars on the side, and connect companies to their network. These future part-time VC’s will raise money on the platform at will. Their investments would be mostly in confidential rounds closed to the general public.

Approach

Some online fundraising models are much better for founders than others. In summary, funds are the cleanest and most attractive option. Syndicates from top angel investors and FundersClub listings rank as the next best option. The least attractive options are public fundraises and Title III crowdfunding.

For many companies seeking to raise a seed round, online platforms have proven a viable option. We sent a survey to YC companies that have raised online, and the feedback was very positive. Founders have used online platforms to get a fundraise rolling, to fill out a round that’s almost complete, and to raise a bridge round prior to a larger fundraise. Many companies said that the investors they’ve met through AngelList and FundersClub were some of the most helpful and engaged investors in their company.

Let’s take a closer look at each online fundraising alternative.

Funds

AngelList, FundersClub, and Wefunder all have funds where a manager has discretion to invest money on the platform directly into startups. From a company’s standpoint, this process is no different from raising money from a traditional seed fund. A founder simply negotiates terms with the fund’s lead, who can decide to invest on the spot.

Fundersclub and Wefunder have raised funds that were created specifically to invest in YC companies. AngelList, FundersClub, and Wefunder and have each raised dedicated funds for every YC class, and these sites appoint fund managers to invest their money in a number of YC companies. You can learn more about these dedicated funds online: Wefunder’s “Orange Fund”; FundersClub’s “Accelerate YC”; and AngelList’s YC Funds. FundersClub also raised themed funds that may invest in YC companies, like its VR fund.

These funds are essentially small VC funds that happen to be run by online platforms. Typical check sizes from these Funds range from $50K-$250K.

Syndicates on AngelList

Syndicates typically invest between $100K and $1M, with a $200k average investment. The best way to approach a syndicate is to think of the syndicate lead as an angel investor. Would this syndicate lead be a valuable investor and help the company? A great syndicate lead, like a great angel investor, can add a lot of value to the company. But once a founder finds a great syndicate lead, the founder still will need to evaluate whether the lead can raise money on AngelList. Some syndicate leads will be able to raise more than others based on their reputation; others leads won’t deliver.

We recommend that founders be wary of certain syndicates, because many leads approach companies and are only willing to invest $2-5K themselves. If you do consider this syndicates option, keep in mind these questions:

- Has the syndicate lead raised money in the past? If so, how much?

- Will this be a public or private syndicate? If private, how many syndicate members are there and who are they?

- How much money is in your syndicate? How much of the capital is committed vs uncommitted?

- How much will you personally invest, versus what you hope to raise on the syndicate?

- Have you had AngelList's institutional funds back your deals before? Do you have a relationship with them? If not, why not?

There are some downsides and specific legal issues to syndicates:

1. In a competitive round with a lot of investor interest, syndicates are problematic because you have to reserve them an allocation in the round, but you don’t know if they will invest for several days while everyone decides. This is why we recommend YC companies usually avoid syndicates in the days after demo day when their funding rounds are moving too fast.

2. In a public syndicate, the details of the fundraising round (including confidential information about your company) will be publicly available information on the internet. If a company is simultaneously raising money from conventional investors, the syndicate may negatively affect prospects. Private syndicates may solve most of these issues, which is one reason that AngelList is moving to a private only model.

3. The syndicate lead will be a spokesman for your company in that he/she will be pitching your company to other investors. The lead may be better or worse than the founder in this role, but in any case the founder is losing control over the company’s message.

4. Individual investors in syndicates have few legal rights, but may be annoying if they attempt to meddle in your company’s affairs. From my discussions with these platforms, this problem seems to be rare.

FundersClub / Wefunder Crowdfunded Listings

FundersClub, Wefunder, and other sites like SeedInvest, CircleUp, and EquityNet offer crowdfunded investments on their sites that are mechanically similar to KickStarter. A company works with the site to create an investment page that is available to site members and then people in the site’s communities decide whether to invest. If enough members choose to invest and the company reaches its target fundraising goal, then the deal “tips” and will be funded. Unlike Kickstarter, these campaigns are generally private to the site's closed community of accredited investors.

FundersClub and Wefunder both exercise discretion in allowing companies to raise money on their platform. By accepting only a small, curated percentage of the companies that apply, and actively promoting the companies that pass their high bar, these sites maintain a high success rate. Typical amounts raised from these listings are in the $100-300K range.

Because of their selectivity, FundersClub and Wefunder act as VCs in selecting companies. Similar to approaching VC's, a company is better off getting a personal introduction to them rather than using their online application form. YC companies are able to simply email the founders.

FundersClub is now our recommended choice for this model because some of these companies, including Wefunder, are changing their focus to Title III Crowdfunding.

Title III Crowdfunding

The new kid on the block is called "Title III Crowdfunding", and it is the result of US legislation that for the first time allows non-accredited (i.e. investors that do not have $1mm in liquid net worth) investors to invest in startup companies. Previously, equity crowdfunding sites only permitted accredited investors to participate in their offerings. But in May 2016, Title III of the JOBS Act became effective, and startups are now able to raise money from the general public. Anyone can invest subject to the limits set forth in the Title III rules.

Several sites are now offering this crowdfunding option – the most prolific of which is Wefunder and there is also an AngelList spin-off called Republic. Since the regulations are new, fewer than 100 companies have raised money via public crowdfunding, but companies that have struggled to raise money conventionally have had successful campaigns. One of the interesting consequences of this type off fundraising option is that now companies can allow their users to invest. Companies that don't need to raise money may use this option in the future just to give their users a stake in their success.

To conduct a Title III fundraise, a company must disclose a lot of information about its business to the public. If a company has competitors, this option may be unwise. Also, there are substantial legal requirements and ongoing obligations that companies will need to understand.

The regulations related to crowdfunding are still in flux. Congress’ original regulations need to be revised (for reasons explained here) and unless fixed, this model likely will not gain widespread adoption. We do anticipate further changes to this model, perhaps as soon as December, 2016. Until these rules change, there is too much uncertainty related to Title III and I would not recommend this option for most startups. If a company has an avid user community anxious to invest, then this option may make sense.

Conclusion

Raising money online is evolving rapidly. The models from leading crowdfunding sites no longer look like they used to: they are more sophisticated, have access to institutional money and offer greater levels of privacy than they had in their earliest forms. But if you’re raising money online, you need to understand the pros and cons of the platform you’re choosing.

Footnotes

On AngelList, when someone "backs" a syndicate (i.e. signs up to be an investor), they can either be committed or uncommitted. An uncommitted investor is exactly what it sounds like they - they have made zero promises, and are only signing up for the investor's newsletter of potential investments.↩

If the legal docs are not drafted correctly, then a company can be creating problems. For instance, once a company has more than 2,000 shareholders, it is forced to file financials and become a public company. There is information related to this important topic from this article from Wefunder.↩