The next era of crowdfunding begins May 16.
From that Monday, entrepreneurs can raise money by selling pieces of their companies to anyone with the cash and the interest. Before this rule change, entrepreneurs could only raise funds with equity crowdfunding from accredited investors, or those investors who meet certain thresholds of wealth.
Widening the pool of individuals who can invest in startups essentially opens a new spigot of capital for startups.
“This should be good news for entrepreneurs because it will open additional sources of funds for those seeking to build their companies,” says Jonathan Medved, the founder and CEO of equity crowdfunding platform OurCrowd. “While there are tens of millions of dollars available through venture capital funds and angel investors to help entrepreneurs make their dreams come true, the proliferation of platforms for accredited and non-accredited investors via equity crowdfunding is quite good news for entrepreneurs.”
However, equity crowdfunding is not an appropriate funding mechanism for every business seeking capital to launch or grow a business.
So who is it right for? Which entrepreneurs are best suited to this new kind of fundraising? To be sure, there are always exceptions, but here are some guidelines.
Startups for which a small round will make a big impact
Most important, equity crowdfunding rounds are generally on the smaller side of startup funding raises. You won’t see Uber cashing in on a $1 billion funding raise on an equity crowdfunding platform. Instead, equity crowdfunding will be appealing to "mostly small businesses and startups that don't have access to other capital and where a few hundred thousand dollars will having a meaningful impact," says Brandon Jenkins, the chief operating officer of real estate equity crowdfunding platform Fundrise.
Startups that are familiar with crowdfunding
Also, entrepreneurs who already have had some level of familiarity with crowdfunding are likely to be more willing to be a guinea pig for equity crowdfunding. “Firms who have been successful in other forms of crowdfunding might well explore whether these options make sense for them,” says Richard Swart, the chief strategy officer of equity crowdfunding event platform NextGen Crowdfunding.
Businesses that have a loyal base of customer fans
“Companies that are most likely to be successful raising capital using equity crowdfunding are companies that already have a business with a community following,” says Ellen Grady, a corporate securities attorney at Cozen O’Connor.
Being popular isn’t enough, though. A business set to be a successful candidate for equity crowdfunding also needs to be capable of producing organized financial documents for investors, she says. That said, equity crowdfunding “examples might include an online retail business that has loyal customers but needs capital to open a ‘brick-and-mortar’ location, or a local bakery that wants to open a second location. These types of businesses have a ‘crowd’ that may be interested in supporting their business expansion,” says Grady.
Startups that are good storytellers
For entrepreneurs to be successful in any sort of crowdfunding, they need to be able to tell the story of their business in a captivating and fascinating manner.
“The first companies to raise capital will likely be those who offer a compelling story. Every company will highlight their potential return on investment. But those who take the time to tell their story are much more likely to catch an investor’s eye, says Brian Burt, the chair of the emerging business group and the law firm Snell & Wilmer.
“How does its product truly serve the consumer? What motivated the founders to bring this product to market? How will an investment help the company change the world (at least in some small way)? To the likely crowdfunding investor, these things matter,” he says.
Aaron McDaniel, the CEO of Access Investors Network, a mobile aggregator of hundreds of equity crowdfunding deals, predicts consumer-focused companies will be the first to raise money with equity crowdfunding.
"It is more difficult to explain (and for many people to understand) a complex medical device or an enterprise solution that only people in a niche market would understand,” says McDaniel. “Products with wide appeal that have target customer bases of millions of people will be the most successful in raising funds.”
Startups that aren’t in the headlights of traditional startup investors
Companies that aren’t necessarily getting the attention of mainstream startup investors may see opportunity in equity crowdfunding that they otherwise have struggled to find.
“We’ll see novel and innovative ideas from entrepreneurs that haven’t had access to VCs and angels. For example, if you are an entrepreneur with a great idea for an app but happen to live in Kansas, it’s probably pretty hard to break into the VC community,” say Jeff Annison and Paul Scanlan, co-founders of Legion M, an equity crowdfunding studio for the entertainment industry. Equity crowdfunding may open doors for “early stage companies that have the a great idea, but haven’t gotten to development yet. Over the years, VC and angel investors have been slowly gravitating to later stage investing.”
The flip side of the same coin is that equity crowdfunding may attract second-fiddle businesses that aren’t particularly strong. “At its worst we’ll see companies turn to equity crowdfunding because their business plans aren’t strong enough to get funding elsewhere,” say Annison and Scanlan.
That said, those lackluster businesses aren’t likely get past the wisdom of the crowd. “We don’t expect these companies to experience much success. Equity crowdfunding isn’t easy or inexpensive, and the SEC has important safeguards like bad actor checks and reporting requirements that will eliminate most of the riff-raff,” say Annison and Scanlan. “Plus, the public is sophisticated these days and has access to enough information to make well-informed decisions.”