If you're thinking about raising money through equity crowdfunding, think twice: the numbers are murky, and the question of investor returns is even murkier. Last week, Stephen Wilmot made the case in the Wall Street Journal that early results from the U.K. simply don't add up for investors.
In the U.K.--where equity crowdfunding has been in effect since 2011--only five companies out of nearly 1,000 had achieved exits by late 2016, according to AltFi Data. With these odds, U.K. investors are better off going to the casino and betting on a single number in roulette.
Equity crowdfunding empowers retail investors to play the role of venture capitalist, permitting normal people to invest directly into private companies whose deals were previously limited to wealthy or accredited investors. But, it turns out, they don't just want equal access to investment opportunities. They want liquidity, too.
As an entrepreneur, you need to consider a strategy for providing that liquidity. The old model of raising capital from venture capitalists is precisely that: the old model. With the recent Initial Coin Offering (ICO) phenomena, investors have been given a taste of instant liquidity--and they're hooked. Now, there's no going back.
As the CEO of CrowdfundX--a firm that has marketed historic Regulation A+ IPOs to NYSE, NASDAQ, and OTC Markets Group--I know how much investors value liquidity. And I can tell you that it's much easier to market a deal that intends to IPO versus a startup that needs years of runway to execute on their plans before investors have any shot at generating returns.
How Americans can avoid the U.K.'s disastrous results
In the U.S., equity crowdfunding is often associated with Regulation Crowdfunding, a securities exemption that went into effect in May, 2016. Regulation Crowdfunding allows private companies to raise up to $1.07 million from retail investors, and in 2017, almost $50 million was raised by such startups.
The problem with Regulation Crowdfunding is that it attracts the smallest, generally most desperate issuers, making it a recipe for disaster for investors. More than anything else, its critical flaw is that retail investors are parking their hard-earned cash into extremely high-risk, illiquid assets. As we've learned from our friends across the pond, the likelihood that any of these early-stage startups are acquired--and deliver returns to investors--is slim to none.
Enter Regulation A+, a securities exemption that allows private companies to raise up to $50 million, generally solicit or market their deal, and accept capital from retail investors. The key advantage is that Regulation A+ gives the issuer the option to IPO by listing their shares to a national securities exchange or alternative trading system assuming certain requirements are met.
With Regulation A+ shares freely tradable upon closing, the upside to an IPO is obvious: Investors are liquid upon listing, and can freely trade out of their position assuming there is enough volume. With elevated costs and complexity compared to Regulation Crowdfunding, the Regulation A+ exemption tends to favor more mature, later-stage companies.
Regulation A+, which went into effect in the U.S. in June, 2015, has its own set of challenges. Out of the ten Regulation A+ IPOs achieved to date in the U.S., nine are trading below their IPO price. One. Longfin Corp., just voluntarily de-listed from NASDAQ after the SEC charged the firm with insider trading and securities fraud, freezing $27 million of its assets.
At a minimum, Regulation A+ IPOs give investors immediate liquidity, which must sound like a dream to the U.K. investors whose cash is stuck frozen in hundreds of years-old equity crowdfunded deals.
Another bleeding-edge investment vehicle in the U.S. is a security token offering (STO), a regulated offering in which an issuer--generally in the cryptocurrency space--sells programmable equity to investors. Currently, there are no security token exchanges that have been approved by the SEC, but several, including OpenFinance, Templum, and CoinList are well underway in developing such platforms.
In late April, NASDAQ CEO Adena Friedman even hinted at the possibility of launching a cryptocurrency exchange. If secondary, compliant security token exchanges are approved any time soon, retail investors will have another valuable tool at their disposal to achieve liquidity.
At the end of the day, your investors want to generate a return on their investment. And with a Regulation A+ IPO or STO, your investors just might be able to have their cake--and eat it, too.