Crowd Funding and Job Creation

There seem to be two motivations behind the current buoyant enthusiasm in Congress over crowd funding for entrepreneurs:  1) the democratization of funding for startup companies (no longer requiring such investors be wealthy) and 2) the job creation that is expected to result from creating more startup ventures.  In my earlier post, Crowd Funding – A Critique for Entrepreneurs and Investors, I listed the pros and cons of crowd funding from the perspective of both entrepreneurs and investors.  Now, I would like to provide my perspective on the primary potential benefit to the US economy – job creation.

In 1979, David Birch published The Job Generation Process in which he demonstrated that new companies create the preponderance of new jobs in the US.  This conclusion was validated by many others including the Kauffman Foundation, which at the Obama Jobs Summit 2009 showed that virtually all net new jobs (~3 million per year) in the US are created by companies less than five years old.

But, we have now found that new company formation is necessary but not sufficient at creating new jobs.  Birch and many others have shown that only 2-5% of startups, the “gazelles,” are in fact responsible for almost all of this job creation.  Gazelles are defined as companies with at least $1 million in revenues that grow at rates exceeding 20% per year, when measuring both revenues growth and job creation. For more on gazelles, see Economists Credit Small Business ‘Gazelles’ With Job Creation.

I suspect that crowd funding is more suitable for lifestyle companies (such as local store fronts), than for high-impact (high-growth) companies from which the gazelles emerge.  Why?  Because high-impact companies often need two additional resources to be successful:

1. High-impact startup companies usually need multiple rounds of funding to sustain growth.  It appears that the current legislation in Congress will have an upper limit per company on crowd funding.  If the startup needs more funding than the new regulations allow, the company will be forced to seek angel or VC capital.  But, historically angels and venture capitalists have been very reluctant to provide funding to companies with hundreds or even thousands of existing shareholders (for a variety of reasons).
2. High-impact startup companies often attribute their success, at least in part, to finding “smart money,” that is, investors who bring significant experience and network contacts with their investment capital.  Will crowd investors be “smart money” by bringing their experience and contacts to startups?  The very nature of crowd funding would suggest not.  Can crowd funded companies, nonetheless, attract smart money to invest alongside the crowd sources?  It is not clear.

Many of us in the entrepreneurial community believe that crowd funding could be a wonderful new source of capital for lifestyle companies.  But, there is concern that follow-on investors, such as angels or venture capitalists will be reluctant to provide additional capital to startups who have already raised crowd funding.  Furthermore, crowd funding, by its nature, cannot bring business segment expertise or broad industry network contacts to startup ventures.  Consequently, it does not appear to this angel practitioner that job creating gazelles will emerge from crowd funded companies.  This legislation should not necessarily be viewed as a job creation opportunity.

All opinions expressed are those of the author,  and do not necessarily represent those of Gust.