On May 16th 2016, the SEC will, after a huge delay in even publishing the rules, make the JOBS act final, allowing businesses to use crowdfunding to raise a funding round. This is a great scenario for many entrepreneurs; it's the chance to solicit and raise capital in addition to or instead of difficult-to-access investors who are becoming increasingly scared of taking risks. It specifically removes the need to be an accredited investor in the eyes of the SEC, requiring a certain amount of income over a period of years. Now anyone can jump in and invest on these platforms, which as a founder may be the opportunity necessary to get an amazing idea off the ground. However, it also opens up investors to even more risky situations. While many crowdfunding equity platforms already exist for accredited investors, the danger for both the current and future investors enabled by the JOBS act is clear. "
"Online startup investing platforms have the potential to offer investors access to an asset class that they traditionally have been sidelined from for decades," said Alex Mittal, CEO of FundersClub. "The allure of investing in the next Google, Facebook, or Apple before they make it big is undeniable, but buyer beware. Investing in the world's most promising startups is not as simple as putting up a sign stating you're doing so. Most startups ultimately fail."
Mittal's company, founded in 2012 and regulated as a traditional VC (rather than a JOBS Act crowdfunding portal) differentiates itself in a few ways. This includes having a distributed sourcing network, only taking the top 1-2% of startups it reviews, and using its network to provide value-added connections and advice to portfolio companies through exit or IPO. Mittal's caution is well-placed, with the metaphorical floodgates opening in May allowing millions of new investors to enter the high-risk realm of tech. There are investor protections in place in the form of the Title III mandate of the act, such as the stipulation that companies must secure public accounting firm review or audits of their financials, and regular disclosures and filings. However, the additional overhead makes it comparatively more difficult and expensive for a company to pursue JOBS Act Title III funding. Companies taking Title III funding will also be required to IPO once they take over 500 unaccredited investors and exceed $25M of assets. These measures may make Title III funding an option of last resort.
This is timed with a 40% decrease in global IPO activity according to Seeking Alpha, with many investors' economic fears leading to only two "mega" IPOs (proceeds of over $1 billion) in 2015, compared to 2014's 16 based on data reported by CNBC. To Nextstep Advisory's Barrett Daniels, who had heavy involvement in the IPOs of Tesla and Atlassian, this slowdown--especially with technology companies 0 may be caused by many different factors than investor fears. "The reason for this shift is still being debated on an almost daily basis, but it is likely some combination of a change in the rules, generous funding environment helped by historically low interest rates, additional participation from a new crop of pre-IPO investors that traditionally waited until the IPO, and a curiously timed change in appetite from the rest of the IPO investment community from a grow at all costs strategy to something appearing more responsible." Going public takes a great deal of effort, and the incentives to go public (getting funding) are outweighed by significant paperwork roadblocks when angel, institutional or even crowdfunding-based equity is available. "Many savvy companies were able to make their business better without the scrutiny from the public markets and the additional efforts and costs involved with being a public company," said Daniels.
Other crowd funded equity companies are bullish that this is the future. Tanya Prive of crowdfunding platform Rock the Post said that "while most startups won't achieve Facebook or Dropbox returns (62,000% and 39,000% ROI, respectively), a long-term investment of 5-8 years in the right startup could produce higher returns than any other asset." That is an attractive position for many investors looking for more modest yet substantial returns than a savings account, and other companies like CircleUp report high returns, claiming an Internal Rate of Return of 81%. The worry investors may have is that this statistic only accounts for the thirty percent of their investments that have gone on to raise a follow-on round. This becomes an issue when being an intelligent investor, as that leaves nearly 70% of their portfolio out of the equation. Some are suggesting that crowdfunded investing could also inherently change venture capital, with AngeList's syndicate (that lets you invest in angel investors as if they were funds themselves) letting angels "lead" rounds, if not kill off smaller-tier firms.
If you're concerned, services like Mattermark, which aggregates data on companies' growth and their investments, may be useful for education, as is Crunchbase for finding out about similar investments and their successes (or failures.) To Mittal, May 16 is a day for investors to eye their platforms as carefully as their investments. "Unfortunately, transparency is not the norm in the online or offline startup investing industry, and most players in the market do not make it easy to understand their true performance. Remember to dig deep in evaluating your startup investing partner. Look for a track record of returns (comprehensive, not cherry picked), transparency, process discipline, good feedback from portfolio founders. Judging from the sign on the door alone is likely to leave you empty handed."