Currently, there really is no such thing as equity crowdfunding. This is ironic since about 18 or 36% of the 50 sites I looked at consider themselves equity crowdfunding. I am basically telling them they don’t exist (at least as they seem to consider themselves). Here are my arguments as to why.
- They are exclusive. All of the sites I examined are currently limited to Accredited Investors. This is to be expected since it is the law (in the US at least). However, they are not positioned well to adapt to Title III of the JOBS Act (crowdfunding) when the SEC does deliver approved rules. It does not seem that they intend to adapt. They are exclusive even with accredited investors. In many cases you have to apply to invest. In most cases, the investee chooses the investor (which is the opposite of crowdfunding). This exclusivity also applies to investment opportunities. According to some of the sites’ FAQs, most internet-based intermediaries (or portals as the JOBS Act calls them) heavily vet the opportunities. Some FAQs say they accept less than 5% of opportunities. So the crowd doesn’t vet the opportunities. The intermediary does. This traditional funding “gate”hardly brings forward new startup opportunities. As a consequence there are usually less than a handful of open opportunities on any one portal. Not exactly a thriving crowdfunding marketplace. In addition, many of the sites explain their investor selectivity saying that the investees don’t want a large number of investors because it can hurt their downstream chances for traditional venture capital funding. So they want to choose the fewest number of accredited investors that will give them the most funding. This is a red flag. They really are not interested in crowdfunding. This is traditional angel or private placement investing extended to the internet. I call this Angel iFunding.
- They are expensive. They are expensive for both investors and investees. There are some great analyses of crowdfunding regulatory costs that make the point that raising significant dollars via crowdfunding is not economically feasible for many startups. In many instances there also are heavy transactions fees for both investors and startups. But these factors are still not as burdensome as the current minimum investment requirements. The majority of portals I reviewed had minimums between $10k and $25k USD per investment. There were a few who advertised minimums as low as $5k or even $1k USD. But when I looked at the actual opportunities posted there were none below $10k. Now you could argue that until Title III of the JOBS Act is enacted, the 2000 investor limit by law makes this necessary. And I would agree. But the question is, will this change? It would need to change because these investment minimums are heavy for accredited investors but crushing for the crowd. With the Title III investment limits on crowdfunding a $10k minimum would preclude anyone earning less than $100,000.00 per year. And that is if the investors were willing to put their entire annual crowdfunding investment “egg” in one basket. Not likely. Part of the power of crowdfunding is distributing the funding across a large population of people which also distributes the risk. Due diligence has an entirely different meaning when investing $100.00 or less. So let’s look at due diligence.
- They are opaque. The investment profiles on most of these sites provide very little information on the opportunity and certainly not enough information to make an investment decision. I suppose it is intended to entice the potential investor. Investors must request access to additional materials. I would imagine, considering the investment minimums and the risks of equity investing, that investors would want to do a significant amount of due diligence which might even involve conversations with the startup’s leadership. This kind of due diligence between investors and investees doesn’t scale. And it is anti-crowdfunding.
- They are indirect. With many of the sites you invest in a fund not directly in the startup or you have to actually execute the investment working directly with the startup (the portal playing an advertising/matchmaking role). Wefunder.com is an example of a portal where you invest in one of their funds, a WeFund, and the fund invests in the company. You own a stake in the fund. The fund owns a stake in the company. They are very clear that you have little control over the investment. They decide how and when to execute an exit event. You are along for the ride. Other sites seem to be simply reaching out to accredited investors through the internet to raise capital for funds they are starting. These funds can invest in numerous companies that would qualify under the parameters of the fund. Some of the portal fund managers take 20% of the exit event profit off the top. What a great model for them. They risk your money and take 20% if the investment succeeds. If they can do more volume and keep their management overhead in check they can make a lot of money without bearing the investment risk.
So if they are not crowdfunding, what are they? They are an extension of private placement. They are what I call iFunding. They take the current private placement model and are trying to use the internet to find additional sources to raise capital for their funds and projects.
All of these inhibitors combine to make it a challenging proposition for accredited investors. Remember they are not investment professionals. They have day jobs. What are the chances of large numbers of accredited investors spending the significant time it will take to investigate several iFunding “portals” to find potential investments, request more information on those investments, complete their due diligence, then apply to invest $10k or more and run the risk of being told, “No thanks, you can keep your money.” In my opinion, this model won’t fly even for accredited investors never mind the crowds. The people who will take advantage of this opening up of private placement will mostly be those who are already familiar with the investment and the entrepreneurs involved.
What would need to change for real equity crowdfunding? Just about everything. Their whole approach would need to change, obviously including the four factors I have described above. Will they make the change? Probably not. Crowd is king and because they don’t seem interested in the crowd, they won’t get the crowd. It is more likely that a reward based site like Kickstarter with a thriving marketplace could evolve to equity crowdfunding before these iFunding sites.
I’m always interested in opposing or supporting positions. If anyone knows of an “equity crowdfunding” site that significantly departs from my characterization above then I’d love to look at them.
Comments or opinions expressed on this blog are those of the individual contributors only, and do not necessarily represent the views of Gartner, Inc. or its management. Readers may copy and redistribute blog postings on other blogs, or otherwise for private, non-commercial or journalistic purposes, with attribution to Gartner. This content may not be used for any other purposes in any other formats or media. The content on this blog is provided on an "as-is" basis. Gartner shall not be liable for any damages whatsoever arising out of the content or use of this blog.