Raising Capital in the Time of Coronavirus
The financial crisis has begun. Pundits yell the Coronavirus pandemic is a Black Swan, an event that shocks the financial markets and the economy and one that no one had the ability to predict beforehand.
Time will tell if they are right. However, every crisis invites an opportunity. For the world of equity crowdfunding, this is one of those moments. A crisis like the Coronavirus leads to uncertainty about the future, and that uncertainty can slow things down.
In the context of startup funding, it means that venture capital firms will slow down their decision-making and make fewer deals. Sometimes it means they inject more capital into their existing investments in order to help their portfolio companies weather that uncertainty instead of backing new ideas.
But while venture capitalists are reviewing their list of companies and deciding who will be supported or not, we at StartEngine are onboarding an average of 15 new companies a month (and we could do way more).
The Behavior of Investors in a Crisis
The financial world is sophisticated, but it is also prone to a herd mentality that is not always rational. This very moment is one of those irrational times.
There is high volatility in the capital markets, interest rates are near the bottom, and there is a general sense that our country and the international marketplace are barreling towards a recession.
Coronavirus is not the end of the world, but for startups and early-stage companies, this event could be the nail in the coffin. Why? Because the professionals who invest in risky opportunities are not rational people at this moment.
When times are great, they invest regardless of the valuation. They are attracted by the latest and greatest, the next “Uber for this or that.” They are a herd. Investors go with what the VC next door has already invested in. They are all pursuing outsized returns for the risk.
But when times take a turn for the worse, investors run to the hills and look at their portfolio to make life and death decisions. Which of their companies can survive in an uncertain environment? Who has the cash reserves to survive?
In this environment, venture capital firms take calls, but make few deals. They are gone. The well of VC investment is dry. Angel investors, who are in sync with venture capital, are gone as well.
What are entrepreneurs supposed to do?
A Solution in FinTech
Disruption impacts every industry. The iPhone disrupted telecommunication. Uber and Lyft disrupted transportation. Amazon, retail. FinTech is no exception.
The FinTech disruption can be traced to the advent of companies that are making finance more efficient, more scalable and less costly, ranging from Shopify (facilitating ecommerce) to Stripe (facilitating payments).
These tools have made it possible for startups to do more with less and has opened new doors for entrepreneurs.
In the past, if you removed venture capital firms and angel investors, there were not many financial support options for startups. Banks wouldn’t lend because startups have no assets or free cash flow, and asking entrepreneurs to put everything on the line is too unfair. A more consistent source of capital to entrepreneurs has been their family and friends. But this source has a ceiling that is usually quite low. It’s insufficient to fund an ambitious startup.
FinTech created an alternative. It has enabled new financial models, such as Kickstarter and Indiegogo, that help founders raise capital through pre-product sales or even outright donations. These players have proven that the consumer wants in. Consumers want to be part of the journey of the dreamer and the entrepreneur.
In fact, Indiegogo (founded in 2008) and Kickstarter (founded in 2009) emerged in the wake of the 2008 financial crisis as an alternative means for companies to raise capital.
However, these crowdfunding platforms were limited to very few types of things. For example, popular crowdfunding projects include technological gadgets and non-profit projects. Crowdfunding platforms are great for asking people to donate or participate in a pre-sale rather than to invest, but they are a limited representation of our economy. Many varieties of businesses do not fit into crowdfunding’s mold.
However, with the staggering success these platforms experienced, it lit a light bulb for a whole new possibility: equity crowdfunding.
The Strength of Thousands of Investors
In April 2012, the JOBS Act (the Jumpstart Our Business Startups Act) was signed into law, but the SEC took its time to enable it. In June 2015, the SEC promulgated Regulation A+, which allowed companies to raise up to $50M per year from the general public.
This regulation ushered in the equity crowdfunding revolution. Finally, the general public had access to risky investments, such as startups, as well as other less risky assets, such as real estate. It only took 80 years from the creation of the SEC to allow everyday people to participate in these investment opportunities.
As soon as Regulation A+ went live, platforms such as StartEngine (of which I am the CEO) and Fundrise started to offer investment opportunities to the main street investor.
Soon after, Regulation Crowdfunding was put in place in May 2016. This regulation allowed companies to raise up to $1.07M per year directly from the public, aka the crowd. Regulation Crowdfunding was easier for companies to use because it costs less and has less intensive reporting requirements than Regulation A+.
However, it did require going through SEC-registered funding portals, a list of 50 platforms which include companies like StartEngine, Wefunder and SeedInvest. Regulation Crowdfunding lowered the costs associated with an equity crowdfunding campaign to thousands of dollars, but it also had a ceiling of just over $1M.
It’s worth noting that this ceiling could change in the future. A couple of weeks ago, the SEC decided to revamp Regulation Crowdfunding and Regulation A+ with a list of proposed improvements, which include raising the Reg CF $1.07M ceiling to $5M per year and the Reg A+ $50M limit to $70M per year. This is great news for companies. These changes mean a funding portal could raise up to $5M/year for any company that wants to include the crowd on their cap table.
The Behavior of the Crowd in a Crisis
The Coronavirus crisis has taken our economy for a whirl spin. It has cut ambitious entrepreneurs off from access to capital: the wellsprings of venture capital and angel investments have dried up.
The good news is that there is an alternative source of capital. Just as Kickstarter and Indiegogo blossomed in the years after the 2008 financial crisis, equity crowdfunding has gone in the opposite direction of institutional investment. The space is currently thriving.
I say this because, in the last few weeks, StartEngine itself closed an $8.7M funding round through Regulation A+. In the final 11 days of our campaign in March alone, we raised over $2M. The crowd has demonstrated their belief in the value of equity crowdfunding in the time of Coronavirus.
Simultaneously, the companies on our platform have continued to raise capital. Everyday investors have shown an appetite for startup investment opportunities, even in this time of uncertainty.
The ordinary investor is not Wall Street. The everyday investor is not fully invested in a stock market that represents just 4,700 companies (NASDAQ and NYSE)—for context, there are nearly 6 million businesses in the US. The investors on our platform are not shorting everything and then purchasing calls and puts as the market moves. Instead, they are thoughtful and calm.
Equity crowdfunding provides investment opportunities where the investor can invest directly into a company where they know the name of the CEO and can support that company’s growth from its early days. The crowd has proven their interest in these opportunities.
We have seen hundreds of thousands of investors become accustomed to this new form of investing. Soon, we believe it will be millions.
Equity crowdfunding is here to stay and help entrepreneurs achieve their dreams. We believe in the power of the crowd, and this is why we can remain confident in times of crisis that StartEngine can help entrepreneurs raise the capital they need. Through our platform, businesses can raise funding directly from eager investors who have already shown they are not in a state of panic at today’s market.
This is the beginning of the rise of equity crowdfunding.