Note: These are my thoughts as a non-accredited investor. Many of the platforms I’ve mentioned below only allow accredited investors.
What is Equity Crowdfunding?
Equity Crowdfunding (EC) allows a broad group of investors to fund private companies, usually startups and SMBs. The popularity of this idea has skyrocketed after the SEC decided to open crowdfunding to investors with investments as low at $100. This is an intriguing concept as it allows ‘regular’ people to invest alongside venture capitalists, and high-net worth individuals who participate in private markets in myriad ways. This is a high-risk, high-reward investment option that’ll allow creditors can explore investment opportunities in exciting start-ups using digital platforms.
Still don’t know what exactly it is? Check out some of these companies (non-exhaustive) that have become extremely popular in this space. I’ve personally started investing (albeit, a small amount) through some of these platforms.
While, the benefits for creditors are obvious, it is worth exploring why companies should consider this option.
The consumer viewpoint
EC is an amazing loyalty program. We know that private investors in public markets tend to invest in companies that they are familiar with (not everyone uses financial modeling). They are loyal to the company and want it to succeed. The same concept can be mirrored in private markets. Customers/investors are personally vested to see the stock price soar and are the best marketing team that any firm can find. This, of course, applies primarily to B2C companies. Products that people use on a daily basis (retail, gadgets, food, etc.). Lastly, it makes investors think of the company as consumer-centeric which is an important factor for the company’s success.
Increased deal flow
Before EC, a niche group of well-connected individuals decided on how much to invest. These companies were geographically limited to major innovation hubs (eg. NYC, SFO, Boston, etc.). The entrepreneurs also needed strong ties to this community to start a dialogue. This would prevent seemingly innovative companies with small networks in remote locations to get funding and scale. A digital platform allows angel investing to scale without the limits of geography and personal connections. It promotes diversification for investors across various verticals and investment options.
The traditional model, required a lot of one-on-one meetings. The investors would have to screen through countless business plans to find opportunities that are ripe for investors. Entrepreneurs, who suffer from lack of time, would spend a large portion of it with potential investors.
This model allows investors to quickly scan through multiple companies using a digital platform at their disposal. Venture capital firms have taken this further as Correlation Ventures runs the data it gathers through a predictive analytics algorithm to vet investments. The ones that pass can now be screened holistically by the team.
For entrepreneurs, it allows them to generate adequate capital without the hassle of interviewing with multiple investors. It gives them the opportunity to focus on the growth problems of the business.
The product launch
A successful EC campaign is also a great way to launch your product. Both these events utilize similar elements of marketing and business development. Even if certain investors don’t invest in your product, they have become aware of it and may consider buying the product when the need arises.
Another important aspect that entrepreneurs consider while making investment deals is the autonomy they will enjoy in running their business. You’ll often find entrepreneurs complaining about the lack of freedom in running their business from the pressures they face from their new board members (usually large VC firms). With seemingly large number of investors with small amount of shares, no particular investor usually has the potential to make important decisions.
EC is definitely an exciting space to explore for investors, entrepreneurs, and job seekers. I’ve highlighted some of the high-level benefits of this novel idea, but there are disadvantages as well.
Lack of mentorship
While autonomy is great and respectable, partnership and mentorship are crucial for a company’s success. Large VC firms have experienced professionals and their advice goes a long way in the success of the company. They ‘ve helped launched several companies and often have strong operational and business backgrounds. Having them on the board of your companies allows entrepreneurs to bounce off ideas and solve complex challenges with better direction and confidence. From my readings, these board members often become important mentors for the CEOs of the company and support the ongoing success of the company.
Disclosing to Competitors
If a company decides to go the public funding round, they need to disclose a lot of information about their business publicly. Competitors can take advantage of this information.
Private Investing with Public Discipline
With crowdfunding, private companies are being closely followed by a large group of investors. These investors will track every move of the company. Therefore, many at times these companies will need to take the disciplined approach to avoid aggravating its investors. Startups, especially, need to draw success from unconventional ways. This approach can be disastrous.
Loss of Potential Networks
Apart from mentorship, tradition VC firms have a large network of companies. They are well-recognized in the industry. Start-ups often require warm introductions to their suppliers and buyers and this is often difficult if the company doesn’t have the support of a VC partner.
Planning to go public?
Going public becomes difficult for these companies as well. Unless the companies has been hugely successful and profitable, entrepreneurs will not be able to generate buzz for their company in the public markets. Investment banks like to support IPOs of companies that have been backed by prominent VCs. A lot of investors as well think of investment decisions based on the brand of the company, especially if they don’t use your product.
Lastly, one of the important aspects of Title III of the JOBS Act (SEC Regulation) is that companies are only allowed to raise $1M in a rolling 12-month period. This could be limiting to a company’s operations and growth. There are other legal restrictions as well, but I won’t dive deeper into that in this post.
Both the traditional and EC paths have their advantages as well as disadvantages. This post is not comprehensive about the different factors that would into a company’s capital raising methodology, but hopes to provide a good starting point. And I would say that I’m not an expert in this field either.
I would love to see case studies where entrepreneurs are successfully able to leverage both these options in the best possible way. Please feel free to share your ideas.