Equity crowdfunding for non-accredited investors is just a few days to become reality. In late January 2016, the recently approved Title III of JOBS Act will come into effect. Now anyone can invest in startups.
Until now, startups didn’t have many options to raise funds. Without assets to back them, bank loans were not an option. As such, a venture capital market appeared, with a few companies specialized in financing new operations being the only players available for entrepreneurs.
How traditional VC works
Those companies were the bridge between risky investors and potential game changer companies. Not an ideal setup but with some competition to balance gains. However, the downside was that they could not advertise investments directly to investors. Instead, they had to package startup investments in aggressive risky fund types offered mainly in partnerships with traditional investment hubs. That created problems for these companies to get funds as well. They should offer higher margins to potential handpicked investors who could easily go elsewhere.
However, there were many entrepreneurs around and the few venture capital companies could be sure they would attract projects by hundreds or thousands per month, to the point that no entrepreneur had more than a few minutes of attention from the managers of those companies.
Then crowdfunding came into town. Now customers could buy a product even before its project was completed, being able to be the first to enjoy technological innovations from startup companies. Indiegogo and Kickstarter became the largest players in the world for this type of rewards based crowdfunding.
A little background first: Indiegogo, launched a year earlier than Kickstarter, has a do it yourself platform that allows flexible funding (i.e., the entrepreneur gets the money even if his goal is not achieved), while the latter only accepts fixed goal campaigns. The first is more like a do-it-yourself platform for the entrepreneur, who is in charge of giving money back to people when a project doesn’t reach its goal, while the latter does that automatically.
Those differences make numbers among those two platforms to differ, but they are impressive nonetheless: Indiegogo boasts a not bad rate of 9.8% success, better than the success rate of just having your project evaluated by a VC company (we didn’t say anything about getting funded). But Kickstarter has an astounding 43.4% success rate.
Specifically, equity crowdfunding
However successful, not all crowdfunding demands were being met. People wanted to be part of the companies they were helping. Oculus Rift campaign backlash, a company that managed to raise $2.4 million in their rewards based round and later were bought for $2 billion by Facebook let that clear: people were complaining they were not part of the company.
There was a problem however. Regulation A caps put in place in 1933 by SEC expressly forbid advertising fund-raising initiatives and established several rules that limited risky investments to accredited investors only. Those offers, as such, could not be made to the general public.
That unmet demand raised questions about the limitations, and JOBS Act was passed in 2012, establishing new rules for equity crowdfunding. In the early stages, that was limited to accredited investors only, but we could see an exponential growth of new platforms, especially in real estate market, such as fundrise.com, which managed to raise billions in equity.
Titles III and IV
In 2016 we’ll see a different world in capital formation for startups. With Titles IV and III in effect, businesses can raise funds much more easily. Many will not even barely need a VC company and will be able to keep more equity in house, while receiving less pressure for faster results.
Traditional VC companies now have fierce competition. But that can be an opportunity for them as well. We can expect to see a number of those companies launch their own crowdfunding initiatives, directly aimed at specific projects, according to Title III requirements, for example. And we can see groups of investors join together to form crowdfunding portals. And that’s not just a prediction: it’s already happening elsewhere in the world, such as Dalian Wanda Group crowdfunding portal in China, and Broota, a startup crowdfunding initiative in Brazil.
The road is just up ahead. And the market will surely change fast.