Wittlebee was a successful startup that failed for surprising reasons. In 2011, former Myspace Vice President Sean Percival founded a children’s clothing subscription club. Initial investors contributed a shocking $2.5 million – five times what startups usually raise. The company poached talent, acquired competitors, and grew revenues fast. Then, in 2012, the money disappeared. Wittlebee was sold for pennies on the dollar. Its business model succeeded when financed by a new parent company. The founders failed because the capital market has a gap.

That gap – the “Series A gap” – is the central problem identified in my Bridgefunding: Crowdfunding and the Market for Entrepreneurial Finance, published in the Cornell Journal of Law and Public Policy. It is the space between $1 million and $5 million where startups have trouble raising capital, and it is a direct consequence of how startup financing is structured and regulated.

The gap between angels and VCs

Startup financing follows a predictable cycle. Angel investors – wealthy individuals who meet the SEC’s “accredited investor” definition – typically invest about $400,000 per company. Venture capital firms typically invest about $7 million. Between those two numbers lies a dead zone.

This is not a natural market outcome. It is a regulatory artifact. Angel groups invest relatively small amounts because they are individuals deploying personal capital. Venture capitalists invest large amounts because their fund economics demand it – management fees and carried interest only work at scale. The result is “lumpy” startup investment with a structural hole in the middle.

The ratio of seed-funded to VC-funded companies dropped from about 2:1 to about 4:1 between 2008 and 2012. More companies were getting angel funding, but fewer were graduating to venture capital. One thousand startups were “orphaned” in that period – funded enough to start, but stranded short of the capital needed to scale.

How the JOBS Act missed the mark

Congress passed the Jumpstart Our Business Startups Act of 2012 to address startup capital formation. Title III – Regulation Crowdfunding – allows startups to sell stock online to the general public. The idea was to democratize startup investing.

The problem, I argue, is that the JOBS Act caps crowdfunding raises at $1 million. That puts crowdfunding squarely in competition with angel investors for the earliest, smallest investments – precisely the segment of the market that was already working.

The JOBS Act only allows startups to raise $1 million per year through crowdfunding, which does not address the Series A gap. Instead, it merely allows the general public to compete with professional angel investors to make the first investment in startup companies.

Meanwhile, the real gap – the $1 million to $5 million range where good startups die – remains unaddressed. The law aimed crowdfunding at the wrong market segment.

Making matters worse, the JOBS Act imposed costly antifraud requirements on crowdfunding. Startups must spend up to $150,000 on independent audits, disclosure documents, filing fees, and legal fees before they can sell equity through a funding portal. Raising money from angel investors is not only up to six times cheaper, but angel investment costs are mostly incurred after financing is assured. Crowdfunding forces startups to sink costs up front. Under these conditions, only startups that fail to get angel funding will turn to crowdfunding – a classic adverse selection problem.

The bridgefunding proposal

My solution is elegant: invert the crowdfunding limits. Instead of a $1 million ceiling, set a $1 million floor and a $5 million ceiling.

If existing crowdfunding limitations were inverted – such that startups had a $1 million floor and a $5 million ceiling – it would become rational for high-quality startups to seek crowdfunding for gap financing.

This “bridgefunding” regime would slot crowds into the financing cycle precisely where they are needed – bridging startups from angel funding to venture capital. The proposal has several advantages.

First, it reduces fraud risk. If a startup has already raised $1 million from professional angel investors who conducted due diligence, the crowd can free-ride on that vetting. Angels have already determined the company is legitimate and the founders are competent. Bridgefunding fraud is harder to commit because angels have already done the work.

Second, it addresses business risk more effectively. The biggest danger in early-stage investing is not fraud but startup failure. A company that has survived to the point of needing Series A capital has already proven certain fundamentals – product-market fit, team capacity, initial traction. Crowds investing at the bridgefunding stage face lower business risk than crowds investing at formation.

Third, it leverages what crowds actually do well. Crowds are not sophisticated financial analysts. But they are excellent at generating buzz, validating products, and providing market signals. A bridgefunding campaign doubles as a marketing campaign. The crowd becomes both investor and customer base.

Why game theory matters

I use game theory – specifically the concepts of hold-out and free-rider problems – to demonstrate that the Series A gap is a genuine market failure, not just a temporary mismatch. In the current system, individual angel investors have incentives to hold out rather than lead a round, and potential venture capitalists have incentives to free-ride on others’ due diligence without committing capital. These dynamics systematically prevent coordination in the $1-5 million range.

Bridgefunding solves both problems. The crowd does not face hold-out dynamics because individual contributions are small and no single investor’s participation is decisive. And the free-rider problem is turned into a feature: crowds are supposed to free-ride on angel due diligence. That is the whole point of requiring a $1 million floor.

What this means for you

If you are a startup founder, the current system forces you into an awkward choice: raise a small angel round and hope you can stretch it to venture scale, or burn resources trying to attract VC attention before you are ready. Bridgefunding would create a viable middle path.

If you are a policymaker, the lesson is that crowdfunding regulation should be calibrated to the market segment where crowds can add the most value. That segment is not pre-seed formation – it is the Series A gap.

The JOBS Act was not wrong to bring crowds into startup finance. It was wrong about where to put them.

Read the full article: Seth C. Oranburg, Bridgefunding: Crowdfunding and the Market for Entrepreneurial Finance, 25 Cornell J.L. & Pub. Pol’y 397 (2015).