Amongst all the excitement about crowdfunding, one key group is still skeptical: Venture Capitalists. The JOBS Act aimed to make startup funding more accessible and it is beginning to do so via Regulation CF (Federal Crowdfunding), Regulation A+ offerings and state based crowdfunding. Many offerings have already been launched, some more successful than others, and undoubtedly many more will follow. So why are VC’s not convinced…and is there a way to get them excited?
Venture Capitalists are Skeptical
VC’s assert that equity crowdfunding is impractical because of the number of shareholders it creates and that many of the terms of crowdfunding deals are bad for VC’s and even the investors in the crowdfunding. VCs have expressed concern that too many shareholders complicate and distract business owners, lead to increased risk and liability, and make regulatory compliance more difficult. Equity crowdfunding proponents are pushing back against these concerns. They point to how public companies have been able to effectively manage large shareholder bases and the fact that regulatory guidelines exist to help startups navigate liability and rules. Recently proposed changes to the federal crowdfunding rules would allow crowd investors to invest through a fund rather than hundreds of individuals, making governance much simpler. Some advocates believe that the real concern for VC’s is that VC’s worry about being circumvented as more and more companies go straight to the “crowd” to raise capital.
Some VCs Coming Around?
For all the concern, some VCs seem to be coming around to equity crowdfunding. They have come to see crowdfunding platforms as data repositories from which they can gain real-time feedback as by observing which campaigns are becoming popular. This early market validation is crucial and can allow VCs to do what they have done with successful Kickstarter campaigns, snap them up due to viral Internet popularity. This ability, through a successful crowdfunding raise, to show traction, is one of the key factors VC’s look for in companies.
VC and Crowdfuning Can Thrive Together
It is important to understand that less than three percent (3%) of all companies in the U.S. get funded by venture capital. VC’s have very specific criteria for the kinds of companies in which they invest and most crowdfunded companies will never meet those criteria. While there will be some overlap, most crowdfunded companies either won’t want or need venture money.
When there is overlap, there are some reasons when VC’s might appreciate crowdfunding. Some companies are already doing “side by side” offerings, where VCs get preferred stock with special rights while crowdfunding investors get common stock that have much more limited rights. Doing so could allow for young startups to grow their value by tapping VCs connections and industry acumen while still tapping into the crowd, likely at a lower cost of capital and hopefully a new customer base. Not only would startup leaders and VCs benefit from such an arrangement, but crowdfunding investors would likely experience better growth potential in the value of their ownership stake.
This article was written by attorney Todd Taylor.