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Venture capital funding, while essential to the startup growth ecosystem, is a funding source that makes its way into only a small percentage of companies seeking critical startup and growth funding. The companies that get venture capital fill a narrow band that meet certain strict criteria, leaving many other highly meritorious and worthy companies out in the cold.
Venture capital funds are managed by fund managers entrusted to ensure that the tightest standards are applied to ensure adherence to the criteria checklist. Participation in the funds is limited only to the most wealthy individuals and cash rich institutions, contributing to the elitist image associated with these funds. Certainly, venture capital is not a realistic funding source for the nation’s traditional mainstream businesses that simply don’t get enough boxes checked to qualify as a fast-growth, high-tech enterprise that will be acquired in three to five years. Likewise, nor does venture capital provide a democratic opportunity for participation by those who wish to invest directly into fast growth, high-flying tech companies that lead to the biggest possible return on investment.
This venture capital structure and the regulations that govern participation in them works well because it averages the winners and losers and nets a return to investors who can stomach the ups and downs and afford to be patient to get their money out, let alone a return. However, this structure also inherently creates barriers for many startups that need the money, as well as for individual investors who want to participate but simply don’t qualify.
Until recently, the first shot an average individual investor has to participate in fast-growth companies is to invest in an initial public offering (IPO) of a given company, but by the time this occurs, while much upside still exists, the significant exponential returns are enjoyed by earlier investors, such as the venture capital funds.
But now, equity crowdfunding, which got its start in 2016, is changing that dynamic and opening up a new, more democratically driven funding source to the startups that need the funding, and is provided by the individual investors directly based on their own evaluation and desire to participate.
For the first time, investors could conduct their own analysis and direct investment into startup companies at the very earliest stage of evolution, with a chance to go along for the ride and swing for the fences, as long as both sides met the criteria associated with “Regulation A” offerings.
It’s working! Since its introduction, equity crowdfunding has played a key role in providing many nascent companies with much needed early seed funding in aggregate amounts up to a total of $1.07 million.
Pitchbook indicates that the average seed round investment was $2.2 million in 2020, and since January 2020, approximately $4 billion has been raised globally across more than 6,500 deals that included capital from crowdfunding campaigns.
Now, as confidence has risen in the ability for equity crowdfunding to work, both as it relates to the raising of capital by startups from individual investors, as well as the ability to prevent fraud and other risks to investors and startups alike, the SEC is opening up equity crowdfunding in ways that will have a hand in truly democratizing startup investing.
As of March 15, 2021, startups seeking growth capital in much larger rounds can now look to equity crowdfunding direct investments as a viable alternative or supplement to venture capital funding. Startups can source equity crowdfunding as seed or growth capital, and much like angel funding, this type of capital is more patient.
The recent changes that went into effect by the SEC more than quadrupled the amount startups can raise via equity crowdfunding in a given year, from $1.07 million to $5 million.
These changes are advantageous to both startups seeking capital and individual investors looking to expand their investment portfolios. With the ability to raise more money through equity crowdfunding, startups now have the ability to raise capital when they might otherwise fit the venture capital model. Even for those startups that do qualify, equity crowdfunding might represent an attractive alternative in that startups are no longer forced to be subject to VC fund requirements that can put pressure on young startups to focus on early exits in order to satisfy VC fund managers’ requirements.
As for individual investors, they can pick and choose which companies to support, providing a sense of “psychic return” in addition to the possibility of significant financial return, similar to how angel investors have been able to invest. While the risk is greatest at the earliest stages of investment, individual investors can invest small percentages of their overall investing portfolio, specifically to take a shot at the upside these early stage investments offer.
How do you tap the equity crowdfunding opportunity for your business?
Begin by choosing a platform on which to create and distribute your offering. The most popular sites to consider are:
Then, create your pitch! You’ll want to include all relevant business documentation, including financials and your business plan as part of a due diligence package. Then, investors who are looking for opportunities on equity crowdfunding platforms can review your opportunity and make an investment by following the process outlined by each specific platform to close.
Equity crowdfunding: Key takeaways
The recent regulatory changes to equity crowdfunding will provide both startups and investors with more possibilities for growth; and given that the U.S. Census Bureau indicates that new businesses are forming at the highest rate in 13 years, the timing for this alternative form of direct funding couldn’t be better.
Originally published April 13, 2021.