VCs eye crowdfunding sites as opportunity to find investments

Crowdfunding is beginning to pique the interest of venture firms internationally as a new way to search for investment opportunities, especially for those focused on hardware.

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Year in Review

While the practice of tech startups raising capital via crowdfunding is still in its early days, the crowdfudning sites that have sprung up are helping the VC community track quality deals, especially when it comes to new class of technologies that are rising in prominence, such as 3D printers, wearables, robots and other new hardware devices.

The video game system developer Ouya and the wearable Bluetooth-connected device manufacturer Pebble are two of the more well-known examples of hardware devices that launched via crowdfunding sites. But other startups in recent months have also raised traditional rounds of cash after starting out from Kickstarter or Indiegogo, such as Arkami, Misfit Wearables, Formlabs, Scanadu Scout, Oculus Rift and NanoSatisfi.

Jen McCabe, who leads the hardware initative of VegasTechFund, which is an investor in Scanadu, said the new class of hardware technologies are well suited for a crowdfudning campaign because they can help the startup “iterate,” a term used by the tech industry to test new technologies and roll out experimental uses. For instance, in November, San Francisco-based Coin, which makes a Bluetooth-enabled mobile payment card said after its successful crowdfunding campaign that it would add new features, such as alarm and alerts.

McCabe said crowdfunding also helps to legitimize the companies for potential VCs, who are looking to see if a company can attract customers with its products.

“But typically, even a successful campaign can only attract a couple fo thousand customers, at most,” McCabe said. “You still need to prove the tech and launch a full-scale effort outside of a crowdfunding site for a company to succeed.”

Most notably there’s the popular smartwatch maker Pebble, which in May raised $15 million from Charles River Ventures. Pebble had initally raised $10 million from online crowdfunding site Kickstarter.

“Equity crowdfunding doesn’t necessarily show consumer desire, although it can at times surface, and it can be a good place for people like me to find startups that have had some success raising an early round,” said Annie Kadavy, a venture investor with Charles River Ventures.

“There’s no better way to give entrepreneurs a shot at success early on than to enable more people to gain access to capital,” Kadavy said. Ultimately, I think bolstering the top of the funnel with new startups will increase the number of companies that go on to raise later rounds from traditional VCs.”

Yet another consumer electronics startup, which found prior success on a crowdfunding site, announced in 2013 it raised an institutional round of funding. Arkami raised a $1.8 million Series A round from Gordon Clemons of Verity Ventures, McNeel Capital, Mark Swanson and a number of other veteran angel investors.

The funding round comes about six months after the Aliso Viejo, Calif.-based startup completed a Kickstarter campaign that sold more than 5,000 units of its product myIDkey to about 4,000 people. The sales push via the crowdfunding site, which lasted 30 days, raised about $473,000 from buyers in 85 countries, CEO Benjamin Chen told VCJ.

“For a consumer electronics company like us, which has a product like ours, the validation that comes from a successful crowdfunding campaign is a must for growth,” Chen said. “It shows we’re doing something right.”

Arkami unveiled myIDkey in January 2013 at the Consumer Electronics Show in Las Vegas, where it says it won three innovation awards in the categories of computer peripherals, accessories and personal electronics.

in December, McCabe said she was headed to the CES to start of the new year and was expecting to see a lot of 3D technology.

In addition to using the crowdfunding sites to find deal flow, venture capitalists are betting crowdfunding sites will be successful and are investing in them, as well. Crowdfunding site CircleUp raised a $1.5 million seed round in 2012 from Maveron and Clayton Christensen’s Rose Park Advisors. In May 2013, Union Square Ventures and Google Ventures invested $7.5 million in the company.

CircleUp focuses on helping retail and consumer product companies secure funding.

“Private equity firms want to see at least $10 million in revenue before they will invest, very few will invest below that in the consumer space,” said Ryan Caldbeck, CEO of San Francisco-based CircleUP. ”These can be companies that are growing, but they are too small for PE firms and not the right industry for VC, which typically focuses on tech.”

Since it was created in 2012, CircleUp has helped at least 25 companies raise $25 million. Since raising capital, those companies have reportedly grown at a rate of 80% per year, with their gross margins expanding to 39% from 34%.

“We want to help entrepreneurs get the resources they need to thrive. We launched because we see a huge need, from both entrepreneurs and investors, for our resources,” said Caldbeck.

Plenty of other crowdfunding sites have raised capital as well. For example, in February 2013, Cincinnatti-based SoMoLend Holdings raised $2.18 million from QED Investors and others, including CincyTech, Queen City Angels and Blue Chip Partners, among others.

New York-based crowdfunding platform Kickstarter announced in the fall it has opened up to Canadian projects. The company, founded in 2009, said it has engaged more than 4.6 million people in pledges and funded more than 46,000 projects totaling $734 million.

While some VCs view the new sites as more competition for deals, others argue they don’t really offer competition, because venture capitalists offer something to entrepreneurs that crowdfunding sites do not.

“Companies often need help in more ways than just financially,” Kadavy of CRV said. ”They need help with recruiting, sales and best practices. VCs offer expertise that companies may have a harder time getting from a crowdfunding site.”