The promise of equity crowdfunding is greater, faster and cheaper access to capital. Whether the industry and its prognosticators can deliver, remains unseen. Since we are all drinking the same Kool-Aid, it is likely okay to assume we will eventually get there. In our haste to sell the public on a new, cure-all for the age-old world of finance and investment banking, I think we sometimes fail to appropriately warn of some of the issues that will most certainly arise as equity crowdfunding emerges from adolescence into full maturity.
Investors, regardless of their level of sophistication, are likely to eventually be sold some equity shares in a crowdfund campaign at some point. The SEC will hopefully be able to cull issues inherent with protecting the investor. It’s the entrepreneur that may not see through the iron curtain of crowdfunding propaganda. In an attempt to avoid a hasty sales pitch of crowdfunding’s virtues–particularly when it comes to selling a founder a “bill of goods”–let’s discuss some of the qualitative costs painted against the all-to-frequent backdrop of the perceived benefits of equity crowdfund investing.
Cost vs. Quality vs. Speed
The cost, quality, speed matrix of project management helps clarify the trade-off between having something now, getting it pristine and getting it cheaply. If you want to move more quickly, it will cost you in capital and likely quality. The inverse is also true. This is just as true in capital requisition as it is in project management. When it comes to capital, there is the non-monetary, but sometimes paramount cost of time to market and the quality of the money you’re sourcing.
Time sensitivity can mean the difference between business success and failure, especially if we’re discussing the sexy world of startups. When the length of the runway matters, speed is everything. Entrepreneurs live in much tighter time constraints than the rest of us. They may not be to a bankable stage yet. If an investment banker raising the funds is asked to raise the money within a limited time box, the cost for the capital raise is certainly going to be higher.
Secondly, the sources of the capital may not be as desirable. If you have a prime deal to pitch to potential investors, most entrepreneurs are likely not going to be picky when it comes to the source of the funds, but having that option is helpful, especially given some of the differences in capital sources which we’ll discuss a bit later.
It’s tempting to use broad, blanket statements when referring investor segmentation, but the reality is that the sub-segments of potential investors in any deal can vary as widely as the population at large. For instance, institutional money may come from family offices, private equity groups, private trusts, pension funds or even endowments. And each of these various segments may not behave similarly at all to other investors in what one would expect to be the same investor class.
Luckily if you’re pitching to accredited investors in a Reg D 506(c) offering, you’re still likely to see check sizes regularly above $50,000. Minimum investor thresholds help to consolidate the number of investors into a tight few, but they also help to maintain the quality of your shareholders. It’s what Warren Buffett of Berkshire Hathaway fame refers to as “keeping out the riff raff.” This is already becoming the norm as many of today’s most successful equity crowdfunding deals are being funded by less than ten sophisticated accredited or institutional investors.
A Roadmap for Retail
Individual, retail investors, on the other hand, are perhaps the biggest wildcard when it comes to sourcing financing from the crowd. Will they demand more in attention and time than anticipated? Will this impact the company’s performance? Will investors demand liquidity more quickly than they should?
One of the greatest potential management struggles that will take place after a completed equity crowdfunding campaign, particularly one in the realms of Title IV (and eventually Title III) is what I like to refer to as “corralling the cats.” If not properly managed, investors could provide a source of real pain for the company–particularly on deals that go sour. The rewards-based campaigns that have failed are only a tip of the angry iceberg.
Public companies are likely the best purveyor for how to treat a large investor base without forcing management to take time away from the business to deal with investor relations. Using the backdrop of the public markets, small companies that find themselves with hundreds or even thousands of new shareholders in a true equity crowdfunding deal, are likely to take some tips and management techniques from the thousands of publicly-traded companies that manage this process quarter after quarter.
Take the Money and Run
While we may have discussed some of potential pain points, including a few reasons to take money from one group while avoiding another, the reality is that raising capital for a business can be extremely difficult. Most often, if investors believe in you, your team and your plan and are ultimately willing to fork over their hard-earned cash, then take it. Take the money and don’t look back. If you have the unique option of filtering through investors or having a benevolent uncle who doesn’t care if he loses a few mil, then great. Unfortunately, that’s a pipe dream for most entrepreneurs seeking capital.
The promise of crowdfunding is unfortunately not a cure-all for small business capital formation, but it should help to bring faster and cheaper capital to a currently illiquid private market. Determining the choice and path in that journey will require a detailed look at the business, its current cost of capital, the end-goal and the type of investors that will help you get there.