The flow of venture capital in 2020 has been surprisingly strong given the year’s general uncertainty, but while investors have showered plenty of dough on growth-stage companies, seed-stage startups are down 32% last quarter compared to the year before.
There have been plenty of recent conversations about alternative funding routes for founders, and one of those oft-overlooked paths has been equity crowdfunding. While crowdfunding platforms like Kickstarter push consumers to back unrealized projects in exchange for products or other services, equity crowdfunding allows consumers to actually invest cash and receive a piece of the company. It’s not a conventional path, but it can be a viable option for companies that have a close relationship with an engaged customer base.
The Security and Exchange Commission’s Regulation Crowdfunding guidelines were adopted under Title III of the JOBS Act back in 2016, but because many entrepreneurs were unfamiliar with how to participate, many of the startups that have taken advantage of it haven’t been the highest quality. The tide could be turning: This week, the SEC updated some of its guidance on crowdfunding, eliminating some ambiguities and increasing the amount of capital companies can raise from both accredited and nonaccredited investors. Additionally, companies can now raise $5 million per year using equity crowdfunding, compared to the previous limit of $1.07 million.
But life has gotten easier in other ways as well for founders pursuing this fundraising type and the platforms that seek to simplify it.
Wefunder is one of a handful of equity crowdfunding platforms that have popped up in the last few years. Before a company can raise on its platform, Wefunder vets them before allowing them to tap into their network of amateur investors who can invest as little as $100 with the median investment sitting at $250. Last month, 40 companies launched on Wefunder and collectively raised $12 million, according to Wefunder CEO Nicholas Tommarello.
Other popular equity crowdfunding platforms include StartEngine, SeedInvest and Binance-backed Republic.
While the gray areas of the regulation likely kept some founders away, Tommarello says this week’s updates will make life easier for startups.
“Before companies needed to do a bunch of compliance work to get their accounting in order, and only then figure out if people wanted to invest in them,” he told TechCrunch. “With these new rules, founders can get solicitations for people to invest in them, and if they get the investments then they can do the accounting work, so it’s much easier for them to get funding without taking any risk.”
Tommarello noted other quirks, such as unclear rules that indicated founders might have to take their companies public if they crossed the threshold of having 500 investors, a major uncertainty that was mitigated with the SEC’s updated guidance.
The SEC’s latest guidelines for Regulation Crowdfunding will likely go into effect in the next couple months.
With some of these updates, the hope is that more substantive companies will take the plunge and ultimately improve the pool of options for the investors using these platforms. There have already been a handful of successful companies that took advantage of investment vehicles outlined in the JOBS Act, including Miso Robotics and NowRX, but the quality of the overall pool has been lacking at times.
“There was definitely some adverse selection [early on],” Tommarello says. “But, each time we fund a company that later on is a success, it reduces that stigma.”
Other changes separate from this week’s SEC announcement aim to improve the chances that investors can actually bag a profit.
In equity crowdfunding’s early days, amateur investors who backed startups were probably getting worse terms than professional investors, but without voting rights they were in a tough position to protect themselves. Tommarello says that as a result of being able to aggregate investors into a single entity, Wefunder permits startups to designate a lead investor for a round who has voting rights.
The average backer putting $250 in still doesn’t have a vote and there are still the same risks early-stage investors face in terms of liquidation rights, but the idea is that there is someone to defend the interests of a round’s participants.
While the rule changes have improved the experience, there are still areas that platforms like Wefunder hope can be further simplified including the path toward amateurs becoming accredited investors who can more easily invest in private companies. Ultimately, Tommarello says he hopes updated rules will provide founders with more options and an easier way to get started with equity crowdfunding as an alternative or in addition to traditional fundraising paths.
“If somebody wants to raise $10 million in VC, that’s great, they can do that and reserve a small part of the round for their most passionate fans or users as well.”