Crowdfunding will likely be one of the top trending search words on Google this year – as well as within the Venture Capital Community. It’s somewhat easy to understand the buzz around crowdfunding when reading about crazy-successful campaigns such as the $10M raise by Canadian-founded Pebble Technology, the $8.5M raise by Ouya, or even the Tesla Museum $1.3M raise. But there is more. While donation and reward driven crowdfunding leader Kickstarter prides itself for having enabled over $473M (as of March 2013) in successful funding campaigns, the peer-to-peer lending company Lending Club has originated over $1.5B in loans and are now filing for an IPO.
So, when will equity crowdfunding hit home? It already has!
Equity-based crowdfunding got the bulk of the media attention over the last year, in big part due to President Obama’s announcement of the Jumpstart Our Business Startups Act (“JOBS Act”) in late April 2012. But interestingly enough, since that announcement, the equity crowdfunding rules and the necessary changes in regulations seem to be stuck in limbo.
While the Securities and Exchange Commission’s (“SEC”) rule-setting period has taken longer than originally planned, it is taking the process seriously and many other security commissions have engaged in a series of consultations and reviews. The Ontario Securities Commission was the first Canadian organization to release a paper intended to initiate a broad consultative process to consider a number of potential new capital raising prospectus exemptions. This was quickly followed by British Columbia and Alberta, while the AMF, the provincial authority in Québec in charge of regulating financial markets, held its first public consultation in March.
Because crowdfunding is an excellent medium for small entrepreneurs to get their message out inexpensively, build awareness, engage customers and raise capital, equity crowdfunding is picking up speed and a number of platforms are already proving successful.
In a nutshell, there are three types of crowdfunding platforms to be aware of:
- Perks & Donation Based Crowdfunding: Kickstarter and Indiegogo are the North American platform leaders in this category and Pebble Technologies is the poster-child. Pebble raised over $10M in donations and pre-orders. A startup founded by two young Canadian entrepreneurs who had trouble convincing venture capital funds of their smart-watch product market potential.
- Lending Based Crowdfunding: Investors are repaid for their investment over a period of time and the higher the risk level, the higher the interest rate is. Lending Club is by far the leader in the US market, however, it seems that its Canadian equivalent, Community Lend, hasn’t been as successful and the regulatory hurdles got the best of the company.
- Equity Based Crowdfunding: When investors get a piece of the company. This is pure equity financing, which is currently only available to Accredited Investors. The unofficial leaders here are Angel List, Founders Club and Crowd Funder.
Although the above list of crowdfunding platforms have made the headlines, our research already discovered over 800 different platforms around the world. And a recent industry report, from Massolutions and Crowdsourcing.org, highlighted that last year alone over $2.7B was successfully raised from a researched group of 308 crowdfunding platforms and it is expected to grow to $5.1B in 2013.
So, what does this mean for the future of seed and early stage financing – where angels and seed funds make most of their returns? Some will say that when unsophisticated investors enter into a new market it increases the likelihood of fraud and that the most promising startups still will go to traditional VCs for their industry knowledge and relationships. Therefore, the less likely to succeed companies will go to the crowds for funding, and by such, provide little returns.
The future of equity-based crowdfunding remains unclear, yet in my view, it’s inevitable and is critical that the Venture Capital Community understands its potential, its impact on the existing VC models and, most importantly, that we take a leadership role by providing guidance and direction.
While many professional investors remain concerned, many questions remain unanswered:
- Appropriate company reporting requirements;
- Status about the Audited Financial Statements and associated costs;
- Share categories and voting rights, or voting trust;
- Issues related to dealing with a large number of small stakeholders when the time comes to do a subsequent financing round or negotiate a sale of the company;
- The practically inexistent secondary market to support consolidation of shares and liquidity;
- The limits in terms of investment size for both an investor and the company;
- And the list goes on, and on, and on…
It is yet to be proven if equity-based crowdfunding will create a much more efficient early-stage capital market. But later this year, we will start hearing about some extraordinary tech companies literally “jump” from a crowdfunded seed stage to a late stage financing round – both in size and valuation. That will spark even more interest for this new type of financing.
Not that different from today’s “democratization of financing”:
Back in 1996, when the Media moguls met with a round table of early bloggers to better understand the “Web” phenomenon and what was behind the “democratization of content”, not one took the discussion seriously. Understandably, how could non-professional writers with a simple Internet access ever be able to compete with the massive, well funded, profitable and extremely well organized network of Media companies?
Impossible, is what they said!