May 16 will usher in a whole new funding launchpad for startups. So what will the world look like on May 17?
Despite unprecedented levels of excitement from industry insiders, the world of finance won’t change magically. It will be a long, halting, at times painful process of transformation.
Equity crowdfunding, whereby an entrepreneur sells pieces of his or her business in exchange for cash, has historically only been available to accredited investors, or those investors who meet sufficient levels of wealth. As of Monday, May 16, everyone will be able to participate in equity crowdfunding. As long as an individual has the cash and the interest, he or she can now be a startup investor. That opens up a whole new pipeline of capital for startups.
Here’s a peek into the future of this brand new, eagerly awaited equity crowdfunding industry.
Education is going to be the first, arguably most important hurdle.
There’s going to be a learning curve for everyone involved. As much as May 16 represents a finish line for the crowdfunding industry, it’s also just the starting line.
First of all, there is a lot of highly charged information from a lot of very opinionated stakeholders to sift through. “One of the biggest challenges will be sorting through all the information (and misinformation). Equity crowdfunding is pretty controversial -- lots of people love or hate it,” says Nick Tommarello, the co-founder and CEO of equity crowdfunding platform Wefunder.
For those entrepreneurs and investors who do jump in early on, there is a distinct possibility that everybody will be overly optimistic. That’s dangerous for both sides of the equation.
"For most entrepreneurs and investors taking part in crowdfunding, it will likely be the first time they are raising money or making an investment. This will be a challenge as first-time entrepreneurs learn what it means to have lots of investors with high expectations, and a challenge for first-time investors who probably will be more optimistic than realistic about how the investment will perform,” says Brandon Jenkins, COO of real estate equity crowdfunding platform Fundrise. “Starting a business is hard and roadblocks come up that you can't expect. Getting through these roadblocks together for both entrepreneurs and investors will undoubtedly lead to some growing pains."
What do entrepreneurs need to be ready for?
The first startups that use equity crowdfunding under the new rules are going to be writing their own rules, learning what works and what doesn’t in medias res.
“Early challenges for entrepreneurs will be that it will require a true pioneer to be the first to step out and take advantage of these new rules. That means, that the individual entrepreneurs who are early adopters will have to figure out the successful and unsuccessful tactics to employ when raising capital from a crowd,” says Ron Miller, the CEO of equity crowdfunding platform StartEngine.
Also, the first entrepreneurs to the table won’t have the benefit of an existing network of potential investors following the crowdfunding portals. “It also creates a marketing challenge -- the pioneering companies are bearing the burden of building networks of investors for these crowdfunding portals,” say Jeff Annison and Paul Scanlan, co-founders of Legion M, an equity crowdfunding studio for the entertainment industry.
Entrepreneurs will also need to do careful research on the equity crowdfunding platform they decide to launch their campaign on. Not all campaigns offer the same services, and entrepreneurs should be especially interested in learning what services platforms offer startups when their campaign has concluded.
“Choosing a platform is a very critical component of an equity crowdfunding investor’s journey,” says Jonathan Medved, the founder and CEO of equity crowdfunding platform for accredited investors OurCrowd. “How is your platform set up to manage the investment in a startup post funding? Will they sit on a board? Will they provide you with investment reports and how will they provide added value to the companies they invest in? Startup companies need assistance not only to raise funding, but also require help in countless areas such as business development and raising additional funds.”
OurCrowd is encouraged by the move by the SEC to open equity crowdfunding to everybody, but it is not going to offer equity crowdfunding for unaccredited investors on its platform.
What do investors need to be ready for?
Picking a successful startup is an art that requires a real stomach for loss. “It’s likely that a high percentage of crowdfunding investors will lose their entire investments. The investors’ challenge will be to find gold in the alluvium,” says David Fischer, a partner at the law firm Loeb & Loeb with experience in securities regulation.
That said, for those willing to toe the line, there is a real possibility to be successful, both in making money and in learning how equity crowdfunding works before everyone else does.
“For the investors, we believe it’s a terrific time. There will be overhead of getting up to speed on the new portals, but early-adopter investors will have opportunities that may not be available as equity crowdfunding becomes more mainstream, plus the chance to gain experience that will serve them will as the ecosystem grows,” say Annison and Scanlan.
The best defense against the inevitable risk is to be sure that new investors don’t bet their life savings, and that they spread their money across multiple investments.
“For investors, there are few challenges other than to remember the importance of diversification. Investors should only place a small percentage of their overall wealth in these high risk, high return opportunities,” says Miller. “Second, within this sector they should diversify among as many different companies as possible.”
In addition to diversification, early stage investors are going to have to learn just how to be patient. Investing in companies of any size isn’t a way to make a quick buck. It’s a long-term strategy.
“Investors in all early stage securities know that bad news always comes before the good, meaning that firms who go out of business tend to do so faster than the firms that have exit events and provide returns to investors,” says Richard Swart, the chief strategy officer of equity crowdfunding event platform NextGen Crowdfunding. “If investors are educated about investing in early stage companies, and have diversified their investments, they can and should ride out the inevitable failure of some firms. However, most investors fear loss more than they appreciate gains and it will take time for the market to learn what the cycle of returns looks like for this form of equity crowdfunding investing.”