Water Water Everywhere, Not a Drop to Drink: Crowdfunding
July 8, 2018
Jokes apart, even startups with a good product idea fail because they couldn’t raise money. A true startup is one that goes deep into the problem, deeper than anyone else has gone and therefore becomes the smartest problem solver in that area.
And for going deep, you need to have the right resources (and therefore money). This important time for young companies is why the early-stage investing ecosystem is critical.
Usually, angel investors (and syndicates) fund these companies and venture capital funds have started seed funds to get early access to companies. There are new options which have emerged, such as Equity Crowdfunding.
Equity Crowdfunding is a way in which a crowd (i.e., many individual investors) can invest in a previously inaccessible asset class.
This development is key, but how can we push the envelope further? How can we get startups to easily raise money in a democratic fashion to provide opportunities for more entrepreneurs?
With traditional investing, it’s not just about the money. The capital comes with support (and connections) to nurture the business, increasing its likelihood of success. Equity crowdfunding often lacks this benefit, meaning that while a business could end up with enough cash, it may lack other critical support needed to grow the business.
There is also another method — take a business loan. Business loans are hard to obtain and carry risks if the business fails. However, they allow the founder more control over her business should it be successful. This is the opposite of equity crowdfunding where there are often lots of investors to split the profits, which comes with reducing the risk of loss.
According to the Massolution Crowding Industry Report, in 2015, the total equity crowdfunding volume worldwide was $2.56 billion. In 2016 it was around $4 billion.
Some bullish estimates, like those by Forbes, a project that equity crowdfunding may very well surpass standard venture capital models in volume by 2020. That projection assumes that equity crowdfunding continues to double every year while venture capital investment holds relatively steady at the $30 billion.
That’s crazy and is just not happening – let’s dive in.
As you can see, some of the big names have only enabled $100-600M in funding and nothing beyond that. In its ~6-year existence, around £500m has been raised via equity crowdfunding in the UK alone.
A great case study for equity crowdfunding platforms is the fast-growing Israel-based platform OurCrowd. Since its inception in 2013, even Ourcrowd has only raised $650 million for 145 startup companies and 12 funds.
They estimate that during 2018, it will surpass $1 billion in assets under management, raised via equity crowdfunding from accredited investors, but that is yet to be seen. While there is great potential and these are early days, all is not hunky dory.
Today, the impact is limited as you can see in the charts (and numbers) below. Perhaps we need something more powerful in this segment. And that is why ICOs (and now STOs) have shown some promise. The dollar figures look big with more than $13B raised so far this year, but the scope is still limited to tech (blockchain) type of companies. It will be interesting to see traditional companies tokenizing their assets and making token sales.
Regulatory clarity provides a clearer path for growth in the US:
This equity crowdfunding model has been troublesome to implement in the past due to SEC regulations. Regulation Crowdfunding (Reg CF) has opened new opportunities to unaccredited investors.
Regulation A is quite old. Reg A is an exemption from registration requirements instituted by securities act that doesn’t exceed $5 million in any one year.
Regulation A+ came into effect July 2015 where you can raise up to $50 million. It’s like a mini-IPO that requires to be qualified by the SEC and is for bigger rounds.
Regulation CF (May 2016; can raise up to $1.07 million; has to be done only through online funding platforms; operated by a registered broker-dealer or a funding portal which is registered with FINRA.)
Offerings under these rules (Reg A+ and Reg CF) gained significant traction in 2017. Out of the 636 companies that filed forms to conduct new offerings under Regulation A+ or Regulation CF, 80% of those issuers (514) filed for Regulation CF. In addition, the number of unique offerings for Regulation CF increased by 267% in 2017 compared to 2016.
My conclusion is that equity crowdfunding is still very much an emerging segment within FinTech. It lacks certain benefits of traditional early-stage investing (lack of support and connections). Even though a number of platforms have mushroomed and thousands of companies are trying to raise funds through this method, I think it is far-fetched to assume it will bypass traditional funding routes.
2017 Global VC Funding Value – $155 billion (Source – KPMG Venture Pulse Q4 2017)
2017 Global Equity Crowdfunding Value – $4 billion (Source – Massolution Crowdfunding Industry Report, MEDICI Estimates).