Crowdfunding is gaining a lot of press. The SEC has finally come out with proposed rules and regulations to allow companies to raise growth equity through crowdfunding. But is that the answer for most entrepreneurs in search of capital?
It’s very important to distinguish between “investment crowdfunding” and “direct investor solicitation”. Most people think of Kickstarter or similar web sites when thinking of “crowdfunding”. On these sites, an entrepreneur may raise some capital as donations, giving investors back product or other promotions, but not equity in the company. Generally the amounts raised are small.
“Investment crowdfunding” rules were just issued by the SEC in October and won’t be effective until May 2016. In investment crowdfunding, companies will be able to raise up to $1 million per year, and unaccredited as well as accredited investors can participate.
While that’s a move forward and will surely seed a lot of companies, most existing companies that have proven concepts need more than $1 million in $5,000 or $10,000 increments.
The JOBS Act also opened the door for “direct investor solicitation”. Before the law changed, companies could not “solicit” for investment. As an example, a company could not run an ad in the Wall Street Journal saying they wanted to raise $5,000,000 in equity. That wasn’t legal. Companies could only solicit from people they knew and had an existing relationship.
The new world allows investors to use direct internet marketing, advertising or other media to tell the world that they want to raise equity. Investors must be accredited, and as in any offering, the company needs to provide full disclosure to investors, including discussing the risks of the investment. But these private placements of equity are now open to the public like never before.
The whole concept of allowing investors direct access to companies, rather than indirect access through venture capital and private equity firms should significantly increase the interest of wealthier investors. As the world moves towards family offices and other investor organizations that are relatively new to the market, companies will have a greater opportunity to raise growth stage investment capital.
While a lot of entrepreneurs will tap crowdfunding to raise up to $1 million, we expect that the dollar volume raised from direct investor solicitation for firms that need $1-10 million will greatly exceed that of crowd funding. Companies that have been starved for capital have a new viable avenue to raise equity capital for growth.
It is an exciting new era that will continue to be rolled out in 2016. Over time, companies are likely to begin raising larger and larger amounts of capital through the direct solicitation of investors.