Country and Western:
Two types of equity crowdfunding
True equity crowdfunding
As we alluded to briefly last time, there’s equity crowdfunding and then there’s equity crowdfunding. Equity crowdfunding models may all look the same cosmetically but they definitely don’t bark the same. The most liberal model, and the path many countries have already headed down, is the ‘true’ equity crowdfunding model we talk about, allowing great flexibility in capital raising across a diverse suite of investors including the retail-level mums and dads that characterise the vast majority of the global population. This looks and feels pretty much the same as the tried and tested rewards-based crowdfunding, but instead of a FlowHive, a Swatch Cube or an Oculus Rift, you receive shares in a company – and often, as a very effective sweetener, you get a few rewards thrown in as well!
At the other end of the equity crowdfunding scale is the effectively rebranded venture capital (VC)/investment banking model where private company capital raising is pitched towards the same VCs, banking and angel groups, albeit now on shiny new front ends. But, in essence, the investment flow to entrepreneurs is the basically the same – less liberal.
From a regulatory perspective, retail-level investors were often excluded from this type of investment from a hegemonic ‘father knows best’ bureaucratic perspective. This pervasive paradigm patronisingly assumes that most people can’t make informed decisions on their own, and is generally reflective of the approach to investment regulation. This heavy-handed top-down over-regulation, purportedly in the public interest, is all well and good but comes with a concomitant stifling of the creativity, adventure and daring that results in cutting-edge innovation.
Of course, there needs to be investor protection and education – and the availability of quality entrepreneur businesses that have been historically the domain of professional investors. At CrowdReady, we’re advocating for decentralisation and liberalising capital flow through empowerment of individuals to make their own choices generally, especially when it comes to their own hard earned.
Democratisation of Capital
Equity crowdfunding provides a very transparent medium of engagement in this regard. And regardless, the immediacy and longevity of electronic media and commerce nowadays has inherent checks and balances as it puts every aspect of the entrepreneur and their deal in the public domain. It is up to the investor to decide, firstly, whether there is sufficient disclosure, and secondly, if what is disclosed represents value for money. The state’s role should thus be limited to providing appropriate guidance to facilitate sound decision making on the investors behalf, and assistance in the prosecution of any fraudulent cases on the entrepreneur’s side of the deal.
So what then are the implications for investors and entrepreneurs in the brave new world of liberalised capital and freer access to start up funding that ‘true’ equity crowdfunding brings? Broadly, there is a binary distinction in equity crowdfunding models – investor-led and entrepreneur-led. In simple terms:
Investor-led (let the experts decide)
Investor-led equity crowdfunding is based on the ‘traditional’ investment banking model and is typically operated by venture capitalists, angels or intermediaries that negotiate with the entrepreneur on funding terms, the novel twist being these deals are then promoted generally to accredited investors only through a (often subscription-only) crowdfunding platform (website).
In general, entrepreneurs will be optimistic with regards to their own valuations and forecasts; VCs, angels and their ilk, pessimistic. The end result is generally that the entrepreneur will end up exchanging more equity than they were willing to give up. Examples of this type of crowdfunding proliferated in the US e.g. AngelList and EquityNet, prior to the passing of Title IV of the JOBS Act which will allow for retail crowdfunding. Many of the current investor-led platforms will likely open the opportunities to retail investors as legislation allows. However, the costs associated with these transactions will remain similar and are generally incurred via an intermediary vehicle with management fees, performance fees (i.e. carried interest) and upfront (platform) fees.
Entrepreneur-led (let the crowd decide)
Entrepreneur-led equity crowdfunding is the ‘purer’ form and most recognisably crowdfunding as it shares similarities with the rewards model. The equity offers tend to be pitched towards retail investors, but increasingly companies are using this model to fast-track capital raises and it is not uncommon for retail investors to invest on equal terms alongside accredited and institutional investors. This is the target model much of the world is already pursuing and we in Australia are aspiring to.
This model places the onus on entrepreneurs to set valuations and determine the terms of the offering to crowd investors. As there is generally no downward pressure on the entrepreneur to exercise cautious ambition - apart from a great motivator: failure - there can be a temptation to overvalue. However, the system is self-regulating as the online nature of crowdfunding campaigns means that the relevant capital raising details are laid bare for the investors to weigh up the relative merits of the offering. We foresee the entrepreneur-led platforms having more involvement in the valuation process over time, including ensuring further investor protection in the terms of the equity raise. Cost wise, this type of equity crowdfunding is generally lower than investor-led deals and incurred mainly via success-based (platform) fees plus ancillary service charges.
Towards a definition of ‘true’ equity crowdfunding
At present, confusion reigns in defining equity crowdfunding given the proliferation of “equity crowdfunding” platforms in jurisdictions where there is no enacted legislation specifically targeting this issue. However, in essence, equity crowdfunding is about democratising capital flows and as such to our thinking is fairly easy to define based on the three criteria below:
- Democratise capital – a campaign created by anyone and open for all investors (over the age of 18);
- Drawing a crowd - publicly advertised via an online crowdfunding platform; and
- Delivering equity - offering equity-style financial interest.
Beyond this there are an almost infinite number of permutations and combinations in implementation mechanisms and term sheet clauses but essentially the three tenets above are the key features of what “true” equity crowdfunding is. There may be restrictions on the amount raised by equity crowdfunding campaigns and/or investor caps (maximum amount an investor can make) and even the disclosure requirements by Issuers. However, if legislation exists around any of these, it implies that there has been jurisdictional consideration and oversight and therefore we consider this to be true equity crowdfunding: open to all.
Whether a campaign is entrepreneur-led or investor-led will inevitably be determined by the crowds’ needs (assisted or unassisted) but we do foresee some shifting sands as the equity crowdfunding eco-system matures.
What is the expectation for Australia?
At the moment we are working very much within the current legislative requirements on raising capital, with equity crowdfunding allowed under an investor-led model but only for wholesale, sophisticated and professional investors (accredited investors) with a cap of 20 retail investors.
‘True’ equity crowdfunding is still on hold and will require a legislative change to allow entrepreneurs to raise money from an unlimited number of non-accredited investors while limiting the compliance, regulatory and cost burdens of public company structures. Until then we’ll continue to keep an eye on the global ranch so that we’re all ahead of the pack when the horse bolts from the stable on equity crowdfunding here in Australia.
Editors note: apologies to Blues Brothers’ fans for the reference to ‘country and western’ in the era-defining movie - https://www.youtube.com/watch?v=cSZfUnCK5qk