Why Crowdfunding Will Fuel an Increase in Companies Going Public

There is no doubt the JOBS Act is a game-changer. It reaches into nearly every aspect of finance and we’ve only really seen the tip of the iceberg. …

There is no doubt the JOBS Act is a game-changer. It reaches into nearly every aspect of finance and we’ve only really seen the tip of the iceberg. The real elephant in the room will emerge when Title III crowdfunding hits for mainstream investors. When this occurs, we’re likely to see, among other things, more startups, greater access to capital and an overall economic boost.

The 500 Shareholder Rule

Before the JOBS Act, private corporations were limited to less than 500 shareholders. Once fully implemented, that threshold increases by 4X to 2,000. This will likely create several problems for private companies especially when it comes to investor relations.

The 2,000 number excludes shareholders who may have obtained shares under an employee compensation plan or those who purchased securities pursuant to the crowdfunding exemption.

Staying Private Longer

Lucky for the founders and management of such firms, having larger thresholds on the number of shareholders for a private company, means more capital can be raised more easily from private investors and companies won’t be forced to go public too early just to get access to capital. However, the $1MM annual limitation may put a damper on high-growth companies needing more capital to keep up with the company’s growth. In such cases, the need for more than $1MM in raised capital year-over-year will likely fuel demand in growth sectors for quick IPOs where capital raising becomes a bit more unlimited, depending on your Broker or Market Maker.

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Business Valuations

I also expect private companies will obtain higher valuations more quickly as a result of the crowdfunding. This valuation boost may likely be carried-over to the IPO and reverse mergers market where companies are generally thought of as 2X (or more) valuable their their private counterparts. Much of that assumption has to do with the liquidity preference theory.

If valuations are high as a private company and they’re expected to increase in a strong bull market once the business goes public, we may see many companies just opt to take the relatively small step of moving over to the public market.

Sellable Shares & Secondary Markets

Another conflicting aspect of the JOBS Act that will contribute to the growth in companies going public will be the sellability of the shares. The JOBS Act also allows non-accredited investors to sell their invested shares on the open market. The problem: no real quality secondary market exists for private company shares. This makes share liquidity, while legal, very difficult for owners of private company stock.

It is important to remember that we’re likely referring to hundreds of companies that are being funding through crowdsourcing. Many owners, without deep investment pockets, may demand liquidity. Secondary markets certainly do exist, but going public creates an immediately liquid environment and lifts some of the other restrictions mentioned previously.

Going Public

While companies will likely be remaining private longer as a result of the new shareholder rules, I’m certain more businesses will opt to become public (perhaps in non-traditional ways) than we may realize. Since having large shareholders typically requires more stringent alignment with GAAP and typical reporting standards, I also imagine the process and preparation for going public in some larger crowdfunding deals will be much easier than many other firms not funded or grown in this way.

In essence, greater access to capital typically becomes a positive feedback loop. More capital at the outset tends to produce more capital and more capital access once the company finally does decide to go public. It’s a win, win, win. Once companies become accustomed to raising money and real growth occurs within their businesses, we’re likely to see companies make more and quicker transitions to the public market.

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