January 1, 2017 marked seven and a half months since the finalization of Regulation Crowdfunding under the Jumpstart Our Business Startups (JOBS) Act. Reg CF was designed to empower startups and small business owners to gain easier access to capital; simultaneously, these changes marked the birth of equity crowdfunding in the United States, ultimately transforming 240 million citizens into potential investors in startups and small businesses. For as little as $100, everyday citizens can own a piece of their favorite company seeking capital to grow. Unfortunately, Wefunder reports only about 22,000 investments have been made to date, totaling nearly $18 million with 70 successful projects - $818 average investment.
Prior to May 16, 2016, everyday citizens did not have the ability to freely invest in startups. At the 5th Annual Global Crowdfunding Convention this summer, I witnessed Vladimir I. Ivanov, Ph.D. Senior Financial Economist at US Securities and Exchange Commission, identified the biggest obstacle to wider Reg CF adoption. He explained that the SEC took three and a half years to finalize the JOBS Act in order to “protect non-investors from unaffordable losses.” Simply put, everyday citizens don’t have the financial literacy to fairly evaluate most potential investment opportunities and now, as investors, they are expected to. This should change over time as more investors gain a better understanding of the concept of equity crowdfunding and the specifics to this new investment class.
Understanding the Reg CF Opportunity for Investors
Most of us have experienced reward crowdfunding through platforms like Kickstarter or Indiegogo. This type of fundraising involves building a campaign around a project with built-in perks at different contribution levels used to entice people to give their money. For instance, the Pebble smartwatch raised over $10 million from 68,929 backers. Backers who contributed $99 were given a Pebble smartwatch that normally retails for $150 – you get their product at a lower cost for helping them bring it to life, if they deliver.
Equity crowdfunding is similar, but backers are given equity instead of a perk or product for their investment in the startup or small business. At this point, the “backer” is now an “investor” and owns shares of stock in that company, but because the company is still private, the shares will be heavily illiquid. This is an important factor to consider because it means that the investor must hold these shares until the company is acquired, goes public, or does a share buyback. This is what’s known as an exit. This can be discouraging for investors that have a shorter time horizon or lower risk profile, especially as investing in startups is typically very risky due to the fact that they aren’t established and aren’t usually earning revenue yet. However, CrunchBase reports the average startup had raised $29.4 million before being acquired for $155.5 million, 7.5x return on money invested, assuming shares aren’t diluted. Not a bad return if you get lucky with your investment.
While many of us working in the industry are hungry for a secondary exchange for Reg CF shares, illiquid shares force investors to evaluate their investment decisions deeper. This is also a benefit to the issuer because they have the opportunity to not only create more loyal brand ambassadors, but gain investor participation when developing ideas for the company. For example, I am an investor in 8tracks, the crowd-curated music platform, and to my surprise was added to a Facebook group with other investors where 8tracks employees asked us for feedback and ideas. What a cool experience!
Where to start? Here’s a list of the Funding Portals currently approved and regulated by FINRA to list equity crowdfunding offerings. Be prepared for a gamble and choose wisely. Nobody gets 7.5x returns without facing a high-risk environment.