Equity Crowdfunding: The Future of Financing

May 26, 2020
Counting Money Image

By Neil Patel, Founder of the Angels & Entrepreneurs Network

The year’s not even halfway over yet, and it’s already shaping up to be one of the most historic periods of the 21st century.

The impacts of the novel coronavirus (COVID-19) on virtually every aspect of our lives – physical, emotional, economic, and societal — are already coming into clear focus.

The entrepreneurial community is far from immune to these impacts. Disrupted supply chains, market pullbacks, and shuttered businesses all serve to add extra strain to a system that was already beginning to splinter under the weight of too many “growth at all costs” failures.

On the startup funding side, we’re seeing valuations drop and deal terms become much less founder-friendly. The fact of the matter is that capital is becoming harder and harder to come by in the current climate… and, as they say, not all money is created equal. Much of the cash that is available comes with a few key caveats that aren’t one-size-fits-all.

Traditional VC Isn’t Going Anywhere… But It Has Its Problems

At times, venture capital can seem like an antiquated system – one that can make life tricky for fledgling companies. But by far the most problematic aspect of traditional VC is that it’s very location-specific. If you aren’t running your business from Los Angeles, New York, or a handful of smaller hotspots, you’re going to have a really hard time finding capital.

Not only does that exclude potentially thousands of amazing businesses from getting what they need; it also ensures that economic growth stays in just a few parts of the country. And that really doesn’t make sense anymore. Why should an amazing business in Utah or Nebraska or Delaware or Florida have to relocate just to get noticed?

There’s A Better And Fairer Way Forward

There’s no shortage of individual investors out there who want to put their own money into startups. Angel investments are arguably the best way that any individual can grow their net worth. Where else in the global markets do you regularly see gains of 10,000% or more make headlines?  Yet until the JOBS Act passed in 2016, everyday Americans were legally barred from investing in private equity of any kind.

This change in legislation made it possible for startups to raise capital via equity crowdfunding, on platforms like Republic, StartEngine, and Wefunder, to name just a few. The JOBS Act opened the door to a new era of private equity – one where the distribution of capital is democratized; where an individual can invest in a startup without the prerequisite of being rich; and where startups seeking funding are judged on the most level playing field there is: The internet. 

So Why Isn’t Everyone On Board?

Crowdfunded raises have somewhat of a stigma in the startup world, possibly because they lack some of the Hollywood glamour of an old-fashioned pitch meeting. They don’t always come with the high-profile connections and pro-level guidance that good VCs bring to the table. And I’ve also heard plenty of concerned chatter about messy cap tables full of potentially thousands of investors.

Here’s the truth: Yes, it feels a little bit less glitzy than a guy handing you a million-dollar check in a Silicon Valley office. And yes, you may bring in hundreds or even thousands of investors when you run a crowdfunded raise. But there are plenty of ways to consolidate those names on a cap table. Plus, thousands of investors mean thousands of new customers… thousands of voices repeating your company’s name to family and friends… and thousands of connections that could prove useful down the road.

Most importantly of all, crowdfunded raises are accessible for businesses located anywhere and everywhere. A startup based in North Dakota could still fill a raise – and that raise could include investors from all 50 states, plus a handful of countries.

So, while the stigma surrounding crowdfunding remains, the benefits are starting to become clear to entrepreneurs — and it’s gaining momentum as a result. In 2019 alone, more than $1.2 billion in capital was raised on the public online equity markets, under either SEC Regulation CF or Regulation A+.

Reg CF, also known as Regulation Crowdfunding, is the more commonly used method due to the low cost and relatively fast launch process. However, Reg CF raises are limited to a maximum raise amount of $1.07 million.

That low maximum has been a limiting factor for the growth of these types of raises. However, new SEC regulations are coming later this year that will completely flip the script… and make crowdfunded raises much more attractive for entrepreneurs than they were before.

Revolutionary Changes Are On The Way

The new regulations remove friction. They will unlock so much more capital for startups, attract an entirely new class of companies to crowdsourced capital, and make it so much easier for investors to get involved in more significant ways than they could before. 

Reg CF raises will see their maximum limits increase nearly five-fold, from $1.07 million to $5 million. The new rules will also reduce the accounting obligations (read: paperwork burden) required of seed-stage companies taking on investors. And Reg A+ raises will balloon to a maximum of $75 million. In addition, the new regulations will ease restrictions on “general solicitation” — in other words, what a startup’s representatives can and cannot say about a future raise.

I believe we’re at the precipice of an historic turning point in the venture capital world. A $5 million upper limit opens the door for much more established companies to enter this playing field for the first time. And, while VC activity is slowly approaching a downturn that could last years, some crowdfunding platforms report that they’ve seen more investor activity during the COVID-19 pandemic than ever before.

All evidence suggests that investors who are registered on crowdfunding platforms are hungry for more opportunities; I recently saw a million-dollar raise fill in under ten hours. And the benefits for entrepreneurs — unprecedented access to capital, minimal loss of equity, free and widespread publicity, and many more — make this an absolute no-brainer to me. A few years back, I had no idea of the power this system is capable of. Today, I ask most of the founders I hear pitches from whether they’ve considered equity crowdfunding — and if not, why?

Obviously, if your next raise is a $40 million Series C and you’ve already got a small army of huge checks lined up, you may be past the point of considering a crowdfunded equity raise. But outside of that scenario, there are very few entrepreneurs that wouldn’t benefit from giving it a try. I certainly believe it’s the future of funding for startups that don’t fit the typical Silicon Valley mold… and it’s ready to take on the world.  

About the Author
Author
Neil Patel

Neil Patel is a New York Times bestselling author. The Wall Street Journal calls him a top influencer on the web, Forbes says he is one of the top-10 marketers, and Entrepreneur Magazine says he created one of the 100 most brilliant companies. Neil was recognized as a top-100 entrepreneur under the age of 30 by President Obama and a top-100 entrepreneur under the age of 35 by the United Nations. Neil is a serial entrepreneur who today runs four companies on a global scale.