4 ways investing in startups will become easier for you «
The JOBS Act, or Jumpstart Our Business Startups Act, became law in 2012 and paved the way for companies to use crowdfunding to access capital. In September, 2013, Title II of the JOBS Act — which allows for general solicitation of accredited investors — was implemented. As of October, however, the Securities and Exchange Commission had merely proposed rules for Title III, which allows unaccredited investors to enter the market.
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How disruptive is crowdfunding, and how will this disruption unfold? Here are four ways the industry could gain momentum in 2014:
1. Title II will grow, but Title III will not. General solicitation will change both private equity and venture capitalism. And deals that take advantage of general solicitation under Title II of JOBS Act will gain popularity.
Deals that allow for non-accredited crowdfunding investors under Title III of the JOBS Act will not gain traction. Though the SEC will enact this new regulation in 2014 (likely in the fourth quarter of the year), few will take advantage of it because of the substantial baggage it carries. Quality companies will look elsewhere for opportunity. This baggage includes:
• Heightened control over sensitive information: Companies have to essentially report their performance to the public (via the SEC), which may be intimidating for many small companies.
• Higher compliance and reporting costs that in many instances require an audit. In my investing career I’ve talked with probably 10,000 small companies (typically $1 million to $100 million in revenue). I would say less than 1% have audits. Try to find a $5 million revenue company that has an annual audit — they typically don’t.
• Restrictions on fundraising: Companies are restricted to raising $1 million in a 12-month period. For quality small businesses needing capital to fuel growth, this restriction is meaningful.
These factors add up to one thing: The only companies that will employ Title III are ones that can’t raise money elsewhere.
This is disappointing, but likely true. Significantly higher administrative costs will serve to segment and limit the market. While wealthy investors will have their pick of the cream of the crop, the average investor will have to sort through lower-quality companies.
Further reform is needed to equalize the market, as the most attractive, high-potential companies are likely to balk at the added administrative burden associated with raising funds from unaccredited investors.
2. Crowdfunders will consolidate. When the JOBS Act passed, hundreds of companies declared their intention to throw their hat into the ring — but most were focused on Title III. Over the past year, many of these would-be crowdfunding upstarts have come to the painful realization that no quality companies will take advantage of Title III, leaving them searching for a sustainable business model.
Beyond this is the fact that venture capital firms have already picked the “winners” — making it harder for second- or third-tier crowdfunding sites to raise meaningful seed or “A” rounds necessary to continue. In addition, the SEC may require equity crowdfunding platforms to register as brokers with FINRA, a process that not all platforms will complete. In a classic Darwinian scenario, the best of the best will come out on top.
3. It’s all about performance. In 2013, stories about how much money various companies raised on crowdfunding sites were a dime a dozen — but investors don’t care about that. Investors care about how their investments perform.
At CircleUp, performance information is disclosed. The average company that has raised money on CircleUp has grown revenue at 80% per year since raising money on the site. In addition those companies have expanded average gross margins to 39% from 34%. These investments are still high-risk, and diversification is critical, but we’re encouraged by that performance. In 2014 all investors on equity crowdfunding sites are going to focus on the performance of the underlying investments.