We keep pretty close tabs on what’s happening in the world of crowdfunding, and as I read the various articles in major publications or see segments on TV news, I am amazed at how little understanding there is about crowdfunding, and the vast differences between the donation-based crowdfunding that’s been around for a number of years, and the equity-based crowdfunding that’s on the very near term horizon.
So let me take a moment to try to explain. Donation-based crowdfunding is pretty simple. People effectively “donate” money to a business or cause with no expectations of ownership. In return, they receive some kind of tangible “award” for their donation and the awards usually come in tiers based on how much one donates. A small donation might result in an award of a bumper sticker or t-shirt while a large donation might garner a first edition product, an all expenses paid weekend trip, or an invitation to an exclusive celebrity-studded launch party. These donation-based platforms, like Kickstarter and hundreds of others, take a percentage fees from funds raised – generally 5-10%.
Equity-based crowdfunding, however, is an entirely different animal altogether, and frankly, much more exciting. Equity crowdfunding has the potential to completely turn the world of finance on its head, by giving everyday investors and small private companies direct access to each other – minus the financial intermediaries, who for decades, have essentially cornered the market on private investments, and have lined their pockets in the process.
The main difference in equity vs. donation crowdfunding is that investors get direct ownership in the company in exchange for their investments – be it shares of stock in a corporation, or units of ownership in an LLC. So instead of a t-shirt from the next iteration of business giants like Google, LinkedIn, Facebook, or Twitter, investors will get to go along for the ride and share in the next wave of new business success (and yes, failure).
But there are also some significant caveats to raising capital through equity crowdfunding: most companies will need to create a business plan, a financial model or audited/certified financial statements, a valuation of their equity offering, and a number of other items before they can list their offering on a SEC-approved website platform.
The next wave of new businesses is likely to be dramatically bolstered by this new access to capital. Instead of a small pool of investors putting capital into new companies, there will soon be billions of people worldwide who can fund tomorrow’s startups.
As things stand today, there are already to significant changes to securities laws in the U.S. around equity crowdfunding -first, companies are already permitted to raise capital via equity crowdfunding from accredited investors (people with significant annual salaries or net worth). And, equity crowdfunders can advertise their deals to those accredited investors, a concept known as “general solicitation”. This hasn’t been allowed since the 1920’s in the U.S.
The third and final piece of the equity crowdfunding puzzle will be when the SEC unveils the rules for allowing equity crowdfunding to non-accredited investors. This is going to be the major pivot point where everyone will be permitted to invest in private companies. Providing the rules for companies to raise this kind of capital are not too cumbersome, this is a BIG DEAL.
Now what’s even more fascinating is to try to predict and understand what could happen once this third and final piece of the equity crowdfunding puzzle is put in place, and by all accounts, this is going to happen some time in the 2nd quarter of 2014.
First, there has been a lot of infrastructure being built behind the scenes to prepare for the events that are now essentially upon us. Institutional investors are not dumb – many have been pouring money into the portals and other businesses that will support equity crowdfunding. Others have been working on creating secondary market for reselling crowdfunding investments which would give the equity crowdfunding market and investors much-needed liquidity – making those investments even more appealing.
And, it’s not just the institutional investors who are making bold moves. Social media companies, media/publishers, and others have been jockeying themselves into position as well by either buying equity crowdfunding infrastructure companies or developing capabilities in-house.
When you think back to the rise of the personal computer market in the 1980’s and the emergence of the Internet in the mid 1990’s, this sea change in the finance industry has the potential to be just as, if not more, prolific. The world forever changed in 1995 when Netscape developed the first web browser and made it freely available. It resulted in the number of web users growing from 16 million at the beginning of 1996 to 360 million by the end of 2000. The share prices of the new companies that evolved, Yahoo, Ebay, Amazon, Priceline, etc., who emerged to service the burgeoning population increased by as much as 100 times between 1996 and 2000. The same is likely to happen to companies who will service the massive population of equity crowdfunding investors.
I recently watched a video at https://www.youtube.com/watch?v=Z987POW-GDc which compared the predicted boom in Crowdfunding that began in 2013 to the boom in the web which began in 1996. The video revealed approximately 20 public companies who are well positioned to benefit from the lifting of the general solicitation ban whose share prices have significantly outperformed the major indices since the SEC announced that it intended to allow general solicitation and accredited equity crowdfunding in July of 2013. It also named 23 private or pre IPO companies who are emerging as leading providers of products and services to an eligible Crowdfunding audience that is projected to grow from 79 million from 2014 to 4 billion by 2018. Take a few minutes to watch this video – it will be time well spent.
So whether you’re a private company, an investor, a wanna-be investor, or an intermediary, the time to position yourself for the coming wave is now. Equity crowdfunding will be the “disintermediation” and the “democratization” of capital and will forever change the landscape of financing the emerging enterprise.