When speaking with investors and (social impact) market influencers about our business and that of our clients, we sometimes hear generic concerns raised about the quality of companies pursuing equity crowdfunding. The clear implication is that, if companies do not raise traditional venture capital investment, then they must not be worthy of “real” investment consideration. This blanket indictment assumes, incorrectly, that the various investment paths under the JOBS Act are only for VC rejects instead of (for many companies) part of a well-reasoned financing strategy.
Leaving aside the well-documented fact that the venture capital industry is (to make an understatement) not exactly a “sure thing” from the perspective of picking investment winners, there are a variety of reasons that companies may not close (or even seek) institutional investment.
For those that would like to pursue venture capital, whether a company obtains such investment may have more to do with the investors than the company. For example, CB Insights and other sources tracking the venture capital industry are abundantly clear that venture capital favors certain geographies. In other words, if a company is not located in the Bay Area or one of the other handful of areas proximate to a pool of institutional investors, then investment is unlikely. However, as Steve Case notes in The Third Wave, innovation is not limited to these areas and, in fact, the “Rise of the Rest” may be empowered, in part, by not being headquartered in such high-cost locales.
Similarly, the data is equally overwhelming that venture capital favors certain sectors (and disfavors others). It does not take a lot of effort in reviewing CB Insights data to see what areas have been funded and then do the math to determine which have not. We work almost exclusively with growth-stage health and sustainability companies and other social impact ventures, and these areas are historically (heavily) under-represented in the institutional investment data. Even though cleantech enjoyed some brief VC popularity earlier this decade, investment dropped precipitously in 2012 and has never recovered (despite unprecedented market growth in green businesses, cleantech or otherwise).
While many quality companies may experience challenges in raising venture capital, others may simply choose not to seek institutional investment. For some, the growth expectations associated with venture capital may not match the business plan. This does not mean that these companies are “lifestyle businesses” but rather that a do-or-die, massive scaling of the business does not match the founders’ plan. By the same token, a company’s current investors may not want their role (or stake) minimized by taking on a new institutional investor or small group of investors (that will demand board control) if tapping into a larger, more diversified pool of investors is a realistic option.
Equity crowdfunding, specifically, may be a better fit than venture investment for companies that are expanding into new geographic markets (domestically or internationally), want to take advantage of raising brand/product awareness in conjunction with their fundraising, or hope to engage their customers as stakeholders in the business (with all of the marketing advantages that makes possible). Beyond the freedom to set their own valuation, these companies may see the benefits of a decentralized set of investors in which (even if 100% accredited investors) no one investor can dictate the company’s path.
Notably, one of the reasons a company may pursue equity crowdfunding is precisely because the executives understand the advantages of crowdfunding when raised in conjunction with professional investment. A company may leverage the (pre-campaign) presence of professional investors in the deal to help deliver a successful crowdfunding experience. Conversely, a company may pursue equity crowdfunding to obtain the sort of market validation needed to position themselves better with institutional investors afterwards.
In this vein, Tim Draper (of Draper Fisher Jurvetson) has stated, “Equity crowdfunding gives entrepreneurs access to a new group of investors who might be great assets to their business. I welcome investing in crowdfunded companies. It means that a company has a large number of promoters before I even invest.” Beyond their post-crowdfunding participation, as Kiki Tidwell has written, “VCs are increasingly joining in crowdfunding sites to syndicate their deals.” And with a thirst for investment liquidity, we fully expect more professional investors to start embracing equity crowdfunding (and the momentum it can generate) as a less costly on-ramp to an IPO.
While we’re still in the very early days of the JOBS Act, Goldman Sachs and other financial analysts have forecasted that the equity crowdfunding market will ultimately surpass marketplace lending:
Clearly, Goldman is not predicting over $1 trillion in addressable market for offerings of only lower echelon investment opportunities. While many companies pursuing equity crowdfunding may not warrant serious investor attention, just because a company seeks a JOBS Act investment path should not relegate the business (or the deal) to second-class-citizen status. On the contrary, the company may be pursuing a more savvy investment strategy than those following a traditional, institutional-investor-led approach.