Funding Speed May Pull Startups Away from VCs
The rise of equity crowdfunding is drawing more interest from U.S. entrepreneurs who can’t get seed-stage funding from a VC, from those who can’t get the money as quickly as the founders would like and from others who simply like the idea of getting buy-in from the mass market.
Some founders also seek this route if they are able to get better deals, or if they don’t want to give up control of their company, a sometimes unwelcome condition of working with a VC.
“Equity crowdfunding will never completely replace the crucial role of seed-staged focused VCs for every company, but it can prove a nice alternative for some entrepreneurs,” says Garrett Black, a senior analyst at PitchBook, a Seattle-based analytics company that follows the VC industry.
Certainly, the availability of crowdfunding is already giving an avenue to companies that VCs turn away. For instance, Iglika B. Ghouse, founder and chief executive of USPAAH, a London-based mobile spa app, says she recently raised £270k on a crowdfunding platform after being turned down by a few VCs. “All in all, each type of funding has its pros and cons, and different startups will be more suited to one or the other depending on their model, stage of growth and needs,” she says.
All types of companies are seeking to raise funds via equity crowdfunding, including some in the payments space. One example is Digitzs, a Santa Monica, California, start-up that helps companies build payments into their platform, app or marketplace. The company is seeking to raise $7.7 million via equity crowdfunding; its CEO told Crowdfunder in August that equity crowdfunding was "the only real option for pre-revenue fundraising."
Some industry participants predict that equity crowdfunding will complement the work that VC firms do. Some companies, for instance, will use equity crowdfunding initially and then seek out VCs for later rounds. Others will choose to work with a VC and still seek to raise additional money through equity crowdfunding, using the VC firm’s brand to lend credence to the offering.
“There are many complementary elements,” says Yuval Ariav, a partner at LionBird Venture Capital, an early-stage VC firm that has offices in Evanston, Illinois and Tel Aviv, Israel. He describes the budding relationship between equity crowdfunding platforms and VC firms as “coopetition”.
Tom Ryan, a partner with Anthemis Group, a fintech-focused venture capital investment and advisory firm based in New York and London, concurs.
“For certain types of companies at certain stages, we offer a lot more than 1,000 individual investors can,” he says. On the other hand, there are many consumer-facing companies for whom equity crowdfunding might be a viable option. “I think there’s a place for both,” he says.
Certainly, the market for equity crowdfunding in this country is still small compared to the venture capital universe of deals—and for good reason. Only recently did the U.S. Securities and Exchange Commission give the green light to allow mainstream equity crowdfunding.
By contrast, venture capital has long been an available funding tool for U.S.-based startups. Venture capital firms in the U.S. invested $59.8 billion in 2015, marking the second highest full year total in the last 20 years, according to PwC MoneyTree Report with data from Thomson Reuters. Of this, about $21.3 billion was invested in seed and early stage companies. By contrast, only 5 percent of all crowdfunding globally is equity-based, though new regulations may shift this trend, the Small Business Association noted in a 2015 issue brief.
“Because crowdfunding is so new in the U.S., I think it’s going to take time to see what the impact of having an additional force of capital from a funding perspective will mean to the VC markets,” says Jeff Grabow, leader of EY’s U.S. venture capital practice.
As more players enter the market, VCs, by nature of competition, are trying to stay relevant by offering favorable terms, a name-brand advantage, industry expertise and the like. This trend is likely to continue as competition from equity crowdfunding heats up.
There are about 600,000 companies created every year in the U.S., and there’s more demand than VCs can meet, according to Howard Marks, executive chairman and co-founder of StartEngine, an equity-crowdfunding platform based in Santa Monica, California. This leaves a real opportunity for equity crowdfunding platforms to fill the gap, he says.
While Marks doesn’t expect that crowdfunding will become an overnight sensation, he predicts that within a few years, as more companies use equity crowdfunding, they’ll realize they can get the money without giving up control, and popularity will spread through word of mouth. Once a critical mass takes notice, VCs will feel the pressure and compete harder for startups. “It’s unavoidable,” he says.
Even so, many VC firms don’t see equity crowdfunding easily replacing VCs’ dominance in financing startups.
For starters, there are limits to how much money companies can raise through equity crowdfunding platforms. In the U.S., companies can raise only up to $50 million a year from unaccredited investors via equity crowdfunding. Also, companies that raise funds through equity crowdfunding have more disclosure requirements. What’s more, VCs say the type of hand-holding they provide can make all the difference when trying to get a company off the ground and in later funding rounds as well.
LionBird’s Ariav, a former entrepreneur, says in his previous role, VCs helped him with things like business advice, company positioning, recruiting and public relations. “For any entrepreneur that’s trying to disrupt an industry, that’s priceless,” he says.
This is especially true when dealing with companies in specialized industries, according to Ariav. LionBird, for example, helps many health care companies work through the FDA regulatory process. This takes a high level of expertise that can’t easily be reproduced by an online platform, Ariav says.
Alexander Jarvis, founder of 50Folds, a global accelerator and incubator, agrees. He stresses the importance of “smart money” that seasoned VC firms offer. With equity crowdfunding, “there is no value-add that comes with the cash,” he says.