Editor's Note: Arlan Hamilton will be appearing at the Inc. Vision Summit on Thursday, March 25.
As one of the first funds to prioritize underrepresented founders, Backstage Capital has long been hailed as an innovator. Now its founder, Arlan Hamilton, is raising money for what could be another breakthrough: hitting the new $5 million crowdfunding limit enacted on Monday.
March 15 marks a key milestone of the Jumpstart Our Business Startups, or JOBS, Act, which then-President Barack Obama authorized to make it easier for small businesses to raise money. The rule change, which was announced by the U.S. Securities and Exchange Commission November 20, sets a $5 million limit for crowdfunding campaigns, up from the previous ceiling of $1.07 million.
The rule change is pivotal for Hamilton's investment firm, and it represents another big step forward for crowdfunding investors and the startups they back. Specifically, the new crowdfunding limits should be a big help to startups reliant on their communities to provide them with early-stage funding, rather than, say, a wealthy family member or angel investor. Crowdfunding also makes it easier for entrepreneurs to keep control of their companies.
Instead of investing directly in a fund operated by Backstage, the company is using crowdfunding to fuel its parent company, Backstage Capital, which runs Backstage's investments and accelerator. In exchange, investors receive a share of the profits and of the management fees generated by Backstage.
"This just seemed like a much cooler, better, and more collaborative way of doing things," says Hamilton. "No one is going to make a million dollars off of this, but when we win the crowd will win."
As of February 1, 2021, Backstage had raised $1.07 million from crowdfunding, which was the most allowed by the SEC at the time. Hamilton hopes to hit the new $5 million cap quickly, as the February round sold out in a matter of hours. Investors reaching the previous cap were offered admission to a waiting list so that they would have a chance to invest if Hamilton decided to raise more. As of 3 p.m. EST on March 15, Backstage had raised about $2.3 million from 3,237 investors.
"There is not a better example of the power of the retail investor," says Ken Nguyen, co-founder and CEO of Republic, the crowdfunding platform chosen by Hamilton. "Venture capital is the most elite form of operation, and she raised the old maximum, of $1.07 million, in hours."
While raising money for a venture firm's operating company probably wouldn't make sense for larger funds, it could show a new way forward for smaller first-time funds. Hamilton says Backstage has raised a few million dollars over several years, with a nontraditional management fee structure. But venture firms don't actually get their management fees until the money is invested, and that takes time. "We have never had enough assets under management at one time where any management fee would cover even one person," says Hamilton, noting that she's spent many sleepless nights wondering how she's going to make payroll. There are six people at Backstage. "We've had trouble raising funds, but we've also invested in 175 companies. We hack our way."
There are other traditions in the venture world that make it even tougher for new managers who aren't independently wealthy. So-called limited partners--the individuals and institutions who invest in venture funds themselves--expect a fund's managers to be investing their own money. Generally, the manager also has to come up with at least 1 percent of the fund's value.
Some managers borrow the money, often from Silicon Valley Bank, a commercial bank known for its focus on entrepreneurs and their investors. Other firms, such as Harlem Capital, have raised a separate pool of money specifically for operating costs. Some funds sell off pieces of their management company, and usually "not at a great rate," says Hamilton. "That happened to me, and I've been very public about that." To get Backstage through 2020, Hamilton had to contribute money out of her own pocket.
The fact that first-time venture capitalists have traditionally had to travel extensively to raise a fund, and then have to endure a lengthy waiting period until their first investments start to provide returns, limits the number of people who can even afford to try to raise a fund. "The system doesn't work for solo emerging managers," says Hamilton. "What we have done could very well be a blueprint, so those founders won't have to sacrifice, as we have had to. I would love to see more of the smaller funds not have to worry like we have had to."