The Best 'Inferior' Companies in the Market
Most people generally don't associate terms like "inferiority" or "inefficiency" with innovation. But those words are exactly the terms that are consistent with true disruptive innovations and the work that I've done in my career.
They are also music to the ears of disruptive financing firms that are focused on attacking inefficient markets with solutions that work for users.
My investment firm, Rose Park Advisors, focuses on disruptive innovation, investing where we feel my research provides us with unique insight on business outcomes. We recently completed a second investment in equity-based crowd funding service CircleUp, and I wanted to share what we think is disruptive about CircleUp's approach.
Disruptive innovation involves a new business model to provide functionally inferior but simpler, more-convenient and less-expensive alternatives to existing solutions. These alternatives appeal to "nonconsumers," those who lack the willingness or ability to pay, or the know-how to access existing solutions.
(Read More: The CNBC Disruptor 50)
Consider the market for financing consumer businesses. If your company is at the high end of the market, with revenue in the tens of millions of dollars, you can pay investment bankers hundreds of thousands of dollars to market your company to private equity funds. Those investors manage lots of money, which means they have to make large investments, which precludes investments in small companies. For technology and technology-driven businesses, venture capital and angel investors serve the low end (small, early stage). But consumer businesses, while accounting for 20 percent of the economy, receive only 5 percent of venture capital and 4 percent of angel funding.
In the language of disruptive innovation, the 1.5 million consumer and retail businesses with annual revenue of less than $10 million are generally nonconsumers of efficient financing. If you're one of those businesses, you're bootstrapping and dependent on family and friends to finance your growth, a less efficient process. The inevitable consequence is that many small consumer businesses fail not because they are not good ideas but because they could not access the money necessary to turn good ideas into success. Even the successes suffer, growing much more slowly than they would have with ample capital.
On the investor side of the financing nonconsumption, less than 10 percent of accredited investors and less than 2 percent of Americans overall participate in private market investments, and financial services firms are narrowly focused on providing sophisticated and expensive services that profitably serve only a small number of potential market participants.
(Read More: Financial Services Disruptors)
Equity crowd funding is an elegant solution to these failures, providing a marketplace that brings together companies and investors on a private and secure online portal. This solution is "inferior" to veteran investment bankers' crisscrossing the country with elaborate pitch books and to venture capitalists' mixing with coveted start-ups at invitation-only events. But with those incumbent solutions essentially unavailable to small consumer businesses and most individual investors, equity crowd funding is highly superior to the relevant alternative: nothing.
So the disruptiveness of crowd funding depends on the particular approach and focus. Within the larger landscape of crowd funding and online investing, sites such as Kickstarter and FundingCircle are disruptive because they fit the characteristics above: They ease access to financing for those companies that historically have struggled to get it and increase participation in new financial categories by making investing easier.
Crowd funding for small technology companies, however, competes head-to-head with well-established, heavily resourced and highly connected venture capital firms and angel networks. In this circumstance, crowd funding services would tend to "win" deals not because they are out of scope or too small for incumbent sources of financing (as small consumer businesses would be) but because they are low quality.
CircleUp, with its equity crowd funding model and focus on small consumer businesses, is positioned for disruptive success by creating tremendous value for companies and investors that are presently served poorly or not at all. Like most disruptive innovations, this model is largely ignored by the larger institutions that dominate the market but will be a big market in the years to come.
_ Clay Christensen is founder and chairman of Rose Park Advisors, a specialized investment firm focused on identifying investment opportunities by applying the framework of disruptive innovation.