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Will Software Disruptors be Disrupted by Equity-Based Crowdfunding?

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There has been a lot of hype about a capital formation tsunami set to hit when equity-based crowdfunding becomes legal. The change has been unfolding over time, and the biggest advance could happen later this year. Title II of the U.S. JOBS Act took effect last September, with new SEC regulations making it easier for entrepreneurs to raise capital by reaching accredited investors through ads and social media. Until then, businesses had been prohibited from using general solicitation for securities since 1933 (80 years). 

The JOBS Act is ultimately expected to pave the way for equity-based crowdfunding under Title III of the Act (also known as the “Crowdfunding Act”), and most believe the SEC is likely to publish final rules in mid to late 2014. This means that equity-based crowdfunding could be allowed by late 2014 or early 2015. 

General consensus among the crowdfunding industry is that the JOBS Act will both disrupt and democratize the venture capital world, turning the tables on the venture financing world by taking advantage of new SEC laws. It will enable consumers to invest in America’s startups and small businesses, introducing a whole new way of funding businesses and creating jobs. 

Venture capitalist Fred Wilson, a partner at Union Square Ventures, postulated in a Forbes.com article entitled “Fred Wilson and The Death of Venture Capital” that if U.S. families were to devote just one percent of their assets to investing in crowdfunding startups, it would “unleash a torrent of $300 billion annually,” dwarfing the traditional VC market as we know it. Mr. Wilson’s comments may be extreme, and some VCs take a very different perspective, claiming crowdfunding won’t even take a bite out of the VC model and poses no competitive risk to traditional VCs. 

The Internet is a powerful thing, and when new regulations allow privately held companies to raise funds directly from the public online and through the use of Twitter, Facebook, LinkedIn and other social media, one thing is for sure: something is going to change. The question is: What will change and how? 

Of course all sectors are not created equally and equity-based crowdfunding will vary widely depending on the sector. For example, the funding process for a favorite local microbrewery with limited investment upside will be very different than that of an emerging robotics company with high growth potential. Let’s limit our discussion to the high-technology and/or “SandHill” sectors, sectors VCs are always looking to “disrupt” by investing in companies that are poised to change the landscape. 

Will the disruptors be disrupted? 

Only time will tell; but I predict that, while the VC model will be disrupted, in the end it will benefit from the new equity-based crowdfunding. 

How? 

First of all, equity crowdfunding deals are limited by law to no more than $1 million, making them a good fit for early-stage deals that normally would not be attractive to most VCs.  

The truth is that angel investing will be disrupted the most, to the advantage of entrepreneurs who will have access to new capital on better terms. But because equity crowdfunding deals are limited by law to no more than $1 million, these deals would not be attractive to most VCs anyway. 

What I see is a new world where partnerships are formed between VCs and crowdfunding firms, in which crowdfunding firms feed the VCs with deal flow, and vice-versa.  

Consider this scenario as an example. Entrepreneur John Doe has created a new social networking app. Mr. Doe pitches his biz to a few Sand Hill VCs. The feedback is “great idea, but you really don’t need $2 million right now. We suggest you crowdfund $500K for your first development and testing phase and come see us when you’re ready for a VC round.” 

Why would a VC suggest this? 

For several reasons:

  • First and foremost, this presents an opportunity for the VC to see if Mr. Doe gets any traction from the public — the very people that would be using his technology. If the public likes his technology, and funds it, it means there may be a big opportunity awaiting, and the VC can assess this without risking a dime.
  • Secondly, there are ways of packaging equity crowdfunding deals so companies that raise funds from the public remain attractive investment opportunities to the VC community, so the VC can still capitalize on the opportunity but with a lower risk.  

Equity-based crowdfunding is going to create more opportunities for VCs and more opportunities for companies seeking funding. While it will take time to evolve, in the end, it will be win-win. And the disruptors, as we know them, will remain alive and well. 

Akhil Garland is the founder and CEO of PeoplesVC, Inc., a crowdfunding company that harnesses the power of the Internet and social networking for rapid change, jobs growth, and innovation. Akhil has raised more than $80 million in funding for his own companies, which include a number of tech startups. 

 

 

 

Comments

By Crowdinvest

Well written and insightful article. Crowdfunding is Still the Disruptor’s Disruptor.

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