An Entrepreneur's Perspective
Entrepreneur-led and investor-led crowdfunding: courses for horses
Following on from our discussion of the implications of investor- and entrepreneur-led equity crowdfunding approaches for investors, this week we focus on entrepreneurs. Here we analyse the relative merits of consulting the experts, or letting the wisdom of the crowd determine the quality of the deal and what this means for entrepreneurs considering equity crowdfunding.
To recap briefly, investor-led equity crowdfunding could be best described as ‘letting the experts decide’ where investment terms are negotiated with professional investors (think Shark Tank). The entrepreneur-led equity crowdfunding model, on the other hand, is ‘letting the crowd decide’ which startups should be funded by promoting the entrepreneur’s deal directly to investors through an online equity crowdfunding platform.
Again we’ve taken a stop light approach to analysing the implications of investor- and entrepreneur-led approaches. Green signifies a favourable impact, orange poses challenges but can be overcome, whilst red signifies a generally unfavourable factor that may require significant time input with no guarantee of a positive outcome. Read on as we compare and contrast the different approaches to leading an equity crowdfunding deal and the consequent implications for entrepreneurs.
There is scant difference in burden with regards to fulfilling the reporting requirements for investors to conduct the necessary due diligence for either investor- or entrepreneur-led deals. The entrepreneur must still prepare all the necessary documentation including detailed business plan, financials, investor decks etc. as required for any equity crowdfunding campaign. Whilst an investor-led approach may have a more formal in-depth due diligence process, the entrepreneur-led model will likely field questions from a myriad of potential investors.
Entrepreneurs are optimistic. As a consequence, they tend to overvalue their business. Under an entrepreneur-led approach this is of obvious benefit to the entrepreneur as they can offer less for more as compared to a negotiated investor-led approach. This isn’t open for wholesale abuse however, as investment terms set by entrepreneurs are inherently self-regulating – i.e. a deal is unlikely to be subscribed to if the valuation is wildly inflated, and there is no room for negotiating once the campaign is launched – its either succeed or fail.
Conversely, given the more cautious views of professional investors, entrepreneurs are likely to forego more equity and with stricter shareholder rights when negotiating deal terms with angels and VCs. In other words, entrepreneurs will forego more control in their business for less capital than they would otherwise have under an entrepreneur-led model.
Upfront costs are more or less the same under either approach, as most of the upfront costs of investor-led approaches are borne by the syndicate and investors. The costs to entrepreneurs are mainly in listing fees and other related upfront costs charged by the intermediary which would be similar under either approach.
In equity crowdfunding, there are generally no ongoing costs for entrepreneurs so both investor- and entrepreneur-led approaches are relatively the same. However, a lead angel or VC may expect an advisory or director’s fee to provide strategic direction.
Access is an interesting area for entrepreneurs where less, may in some cases, be more. Access is important on two levels for companies raising capital: firstly, wider access equals a wider investor pool and therefore more chance of closing a successful funding round. Access is also important in terms of the experience and guidance that investor, particularly professional investor, networks can provide.
In this regard, although the investor-led model may restrict access to individuals in the lead investors network, these individuals may prove to be invaluable to the entrepreneur in terms of the experience and guidance that they bring. This can occur under an entrepreneur-led approach but is much more likely to be a random rather than routine occurrence given the wide investor net cast under this approach.
This has obvious benefits for the entrepreneur under a syndicate-backed investor-led model as they only have to deal with one investor rather than a crowd of investors under an entrepreneur-led approach. This is easier and less costly for the entrepreneur, but only marginally so as establishing a shareholder register and online information flows would not be excessively costly in order to deal with a large number of shareholders.
But transparency is also a key component of many equity crowdfunding campaigns – especially under the entrepreneur-led model – where the campaign can bring a wider audience, new customers, media exposure and potential partners.
An entrepreneur-led campaign likely favours the entrepreneur, as they are the ones setting the terms and this approach would attract more ordinary shareholders who have invested on faith rather than more stringent investment terms. An investor-led approach is likely to be more heavily negotiated with industry professionals. Thus the entrepreneur will, in all likelihood, relinquish greater control of their business under shareholder terms than they would otherwise under an entrepreneur-led campaign. However, the entrepreneur may benefit from the increased investment of energy and experience from lead investors who may feel they have more than just a financial stake in the business.
Time taken to prepare all the proper documentation and pitches would be likely the same under either investor- or entrepreneur-led approaches. In terms of total time spent on capital raising, this is probably slightly biased in favour of the entrepreneur-led approach. Under an investor-led deal negotiation significant time can elapse in the negotiation process, stalling the momentum of the business at a critical stage. In contrast, entrepreneur-led approaches will have a maximum campaign period – on average 45-60 days – after which time the deal closes. The major time spent would be fielding questions from a diverse suite of potential investors however as there is a fixed campaign end date, the entrepreneur can accurately plan ahead under either funded or unfunded scenarios.
As with the implications for investors discussed last time, there is no clearly preferential approach for equity crowdfunding success. Some campaigns may benefit from casting a wide net under an entrepreneur-led approach – think consumer products – as the appeal of the product generates its own interest for investors.
Whilst some innovative consumer products could also benefit from close association with a syndicate of professional angel investors and VCs, there is more likely to be greater incentive via the investor-led model in business-to-business (b2b) propositions that may not otherwise appeal to the larger crowd, despite being a great investment opportunity.
Similarly, campaigns suited to investor-led approaches – think tech startups, disruptive service providers, online commerce – could equally benefit from an entrepreneur-led approach, particularly if the founders accurately diagnose the potential of the business. For example, consider Uber was raising capital in an early growth round. If you were entrepreneurs at Uber, would you rather raise capital under an investor- or entrepreneur-led approach? Conversely, if you were the investor in Uber, would you want to negotiate investment terms or would you be comfortable in the entrepreneurs’ vision to accept their offer? Horses for courses, courses for horses.
Which brings us back to the democratisation of capital. This is decentralised decision making where you determine what is best for you and your company (and investors make the best decisions for their money). As we’ve touched on before, it’s likely that the distinction between both investor- and entrepreneur-led approaches will inevitably reach a form of dynamic equilibrium over time and learned experience. In the meantime it is up to entrepreneurs to decide on the appropriate approach for their campaigns and the costs and benefits of any negotiation on their terms of investment.