It is an excellent time to be establishing a new business. Aside from the scores of accelerator startups, dozens of investors, and programs designed to tailor enterprises to the market, we are seeing a whole variety of other methods of financing becoming available to viable companies. One that has shot to prominence in recent weeks is crowdfunding, following further liberalization by the Securities and Exchange Commission (SEC). In late 2020 the SEC announced improvements and fixes to Regulation Crowdfunding (Reg CF). Crowdfunding is the practice of funding a project or venture by raising small amounts of money from a large number of people, usually over the Internet. The updated rules also provide an exemption from the registration requirements for securities-based crowdfunding, allowing companies to offer and sell up to $5 million of their securities without having to register the offering with the SEC. A 2020 Cambridge Centre for Alternative Finance study found that, although only roughly 22% of surveyed FinTechs were willing to support one or more of the schemes, this shows the great untapped potential for FinTechs to serve as delivery partners in the post-Covid landscape. While this sector of online capital formation had performed relatively well, industry insiders were making noise to have strict regulations loosened and to widen the scope of regulation crowdfunding (Reg CF) from $1.07m from 2017. In March of 2021 new updates to Reg CF went into effect – including the ability to raise up to $5 million – more in line with a seed funding round for a promising startup, with the aim of harmonizing guidelines that establish exemptions for equity crowdfunding, Reg D and Reg A+ offerings.
We will surely see other countries considering opening up crowdfunding which could widen the band of companies that are “backable.”
In short, 1. Regulation Crowdfunding is the basic equity crowdfunding raise for companies, the limit being raised up from $1.07m to $5m, and with availability to all the public. 2. Regulation D, Rule 504 (Reg D) equity crowdfunding has been capped at $10m from $5m, but is exclusively for accredited investors. 3. Regulation A+, Tier II (Reg A+) is for accredited accompanies, now bolstering the cap from $50m to $75m via equity crowdfunding, also available to the layman. The final measures relevant to specifics can be found at the SEC website.
Investing in startups is no longer limited to the wealthy, at the same time that crowdfunding has become a viable option for bootstrappers who need capital but don’t want to get pushed into a supercharged VC timeline. Moreover, whilst money raised from a traditional crowdfunding site like Kickfunder becomes a ‘reward-based revenue’ on a business’ balance sheet, Reg CF or equity crowdfunding amalgamates all investors into one shareholding entity without any of the power associated with a shareholding entity, so founders retain control. SEC regulations permit digitally powering these transactions and opening them up to anyone a founder can email or connect with on LinkedIn. A list of potential investors are sent the offering—it could be a private or public link—and they can invest via the platform, which may take a fee off the top. The situation is similar yet different in the UK. Indeed, the UK has been a pioneer of regulation crowdfunding. In 2000 it would have fallen under the remit of ‘equity’ crowdfunding, (even before the term crowdfunding was coined) under the Financial Services and Markets Act 2000. In March 2014, the FCA (formerly FSA) introduced the new rules to regulate crowdfunding. The new rules aimed to facilitate the development of the industry in order to attract both investors and lenders, protect consumers by ensuring transparency and availability of information, improve the state of the UK financial system, and encourage positive competition in the sector. This was exemplified perfectly in the midst of last year’s pandemic when several UK equity crowdfunding sites delivered government match funding via their sites as part of the “UK Future Fund”, which made it possible for startups with earlier equity-based Crowdfunding to obtain a convertible loan at reduced interest rates.
Although the new SEC regulations were only enacted in March 2021, a number of startups have already benefited from the expanded public investment those regulations allowed. One such success story is Gumroad; CEO Sahil Lavingia of the software company that offers solutions to creators to be distributed directly to consumers feared that his startup would fold under the pressure of being one of the first to test out the SEC’s new regulations, but instead, he was pleasantly surprised when Gumroad finished their investment round in only 12 hours, having in that time raised $5m. Gumroad’s backers invested an average of $679, with 48% investing the maximum amount, and 18% the minimum. The infographic courtesy of Republic (through which the round was led) highlights the mix of entrepreneurs and would-be investors that took a shine to Sahil’s startup, as investment came from every corner from Clubhouse and Twitter to acquaintances.
Another brilliant startup that made use of Republic’s platform is Backstage Capital, an Investment adviser focused on people of color, women, and LGBTQ+ founders, with Founder and Managing Partner Arlan Hamilton at the helm. Taking into account Morgan Stanley’s estimate that there’s $4tn in VC that remains unrealized due to lack of diversity, Backstage’s drive for more representation of women, POC, and LGBTQ folx in spaces of power led it to accomplish its latest $5m investment round in less than 2 months. Republic site boasts of having invested in 160+ companies led by underrepresented founders and notes also that its “first 100 companies raised $250M+ and created over 500 jobs”, making it a large fish in the growing pond.
Another major player in the forefront of the new potential is Y Combinator, a seed funding group which, in an unprecedented move, paired with WeFunder to offer a program of almost 40 startups to investors and the general public. Having backed such household names as DoorDash, Coinbase, and Airbnb, Y Combinator offers Move, a community-owned digital retailer, Agora, a search engine for local products, and Gerostate Alpha, a pharma company dedicated to eradicating age-related diseases, amongst its stacked roster.
How will these new equity crowdfunding regulations change the landscape of the international VC scene, and might Reg CF even supplant VC, or merely add to it? We will surely see other countries considering opening up crowdfunding which could widen the band of companies that are “backable,” if not the band of companies that traditional venture capital players find enticing. Current projections for Alternative Financing are very strong with predictions of the US reaching $2,823.3m in 2021, and with Total transaction value is expected to show an annual growth rate (CAGR 2021-2025) of 7.86% resulting in a projected total amount of US$3,820.8m by 2025. All signs point to more companies accessing funding in this and diverse ways, so investors are advised to watch this space.