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January 19, 2017 | Tom Ballard

OUTLOOK SERIES PART 5: Is crowdfunding making a difference?

2016-outlook(EDITOR’S NOTE: This is the fifth article in our annual multi-part series sharing the insights of angel and venture investors who are either located in East Tennessee or have a specific interest in investment opportunities here. We will be rotating the order of responses on a daily basis.)

Today’s question posed to our angel and venture capital panel was as follows: “We recently saw a report that suggested crowdfunding could surpass venture capital as the largest source of start-up funding as early as 2017. What’s your assessment of that prediction and, more important, the longer term role that crowdfunding will play in years to come?”

Geoff Robson, President, and John Morris, Executive Vice President, The Lighthouse Fund – Morris: Crowdfunding will be an option for seed stage companies, more in the future than now. The only crowdfunding ideas that I have seen work to date have been business to consumer models where the consumer is willing to prepay for the product. Investment through crowdfunding still has room to grow.

Jack Studer, Managing Director, and Courtney Watson, Partner, both with the Chattanooga Renaissance Fund – Studer: Crowdfunding is great for market validation and pre orders. But some of the biggest crowd funding successes (Artiphon and Torch in TN, Coolest Cooler and others on a national scale) still require massive amounts of venture capital to be properly “capitalized.” Watson: In addition to serving as an outlet for market validation prior to traditional venture funding, crowd funding will continue to provide a viable opportunity for investors and businesses/organizations seeking more 1:1 connection. As social impact investing continues to grow along with society’s increased desire for authentic brands/products, crowdfunding serves a beneficial and needed avenue for individuals to launch new businesses. Lastly, with credit markets still being largely inaccessible for early SMBs, crowdfunding helps get these businesses off the ground till they can sustain via operations or secure more traditional bank financing.

Grady Vanderhoofven, Fund Manager of Meritus Ventures and President and CEO of Three Roots Capital – I am a fan of crowdfunding. I believe crowdfunding will play an increasing role in financing companies in the future. I do not believe crowdfunding will surpass venture capital as the largest source of start-up funding in the near future, if ever.

Ken Woody, Partner in Innova Memphis – Crowdfunding is exciting and at the same time concerning. It is great that investors are looking to directly invest in an early stage opportunity. At the same time, if the investment documents and structure are done poorly, it will be difficult for that company to attract critical later stage investment. I’m also concerned about unsophisticated investors not conducting proper due diligence and investing based on unsubstantiated claims. Almost every deal I see looks great on the surface. It takes understanding of the markets and digging into the specific deal, technology, management team, competition, barriers to entry and other keys to success to determine if an investment opportunity is worthwhile.

Eric Dobson, Chief Executive Officer (CEO) of Angel Capital Group – Totally wrong depending on your definition of crowdfunding. Unless the Securities and Exchange Commission (SEC) fixes the crowdfunding rules, then professional investor groups will continue to pan it. Individuals are using crowdfunding, not organized angel capital groups, not VC’s, and not institutional capital. It is important to note that there are essentially four types of “crowdfunding:”

  • Quiet solicitation (accredited investors only) – traditional angel investing without general solicitation to the public (you can do this on AngelList).
  • General solicitation (accredited investors only) – what most people refer to as “crowdfunding” has some draconian penalties for INVESTORS if the COMPANY makes a mistake and investors must explicitly certify their accreditation regularly.  Until this is fixed, don’t expect pros to invest in it.
  • “Everyone else” – a new exemption that allows non-accredited investors to invest $2000 to 10 percent of their annual income in private equity. This essentially allows anyone who wants to do so to invest in private equity companies. However, no start-up wants one thousand $1000 investors.  So, don’t expect hot private equity companies to touch this exemption.
  • RegA+ – essentially a small cap IPO program despite the SEC’s fervent denial that that is what it is. Essentially, a private equity company can raise up to $50M in capital from anyone. The industry insiders see this as an IPO-light and expect private equity exchanges, similar to the public equity exchanges, to form to take advantage of this exemption. It is in its infancy, but holds a lot of promise. Professional investors are expected to take part in this one.

Under the new Administration in Washington, we should reasonably expect to see a much more investor friendly policy at the SEC level, which could potentially rollback some of the constraints on the private equity market that were put in place over the last two decades.

Andrew Goldner, Founding Partner, GrowthX – I think crowdfunding is an interesting space to watch evolve, and it’s an important source of capital to fund ideas (a vacuum that needs to be filled as angels and VCs trend more towards funding products with existing customer traction). That’s an important role for crowdfunding, regardless of whether or when the actual pool of crowdfunding dollars surpasses venture capital.

Tony Lettich, Managing Director, The Angel Roundtable – Crowdfunding is becoming a key component of the entrepreneurial ecosystem and a strong source of funds for the entrepreneur. However, I believe the verdict is still out on the level of success which ultimately accrues to this investment component. In the longer term, we see a melding of angel and venture funding such that investor management platforms like Venture360 and crowdfunding sites are an integral part of the angel and venture funding processes.

Kristina Montague, Managing Partner, The JumpFund – It certainly has been a game-changer, especially for women, who are more likely to have their companies funded through crowdfunding than traditional sources. With the new legislation, crowdfunding opportunity will continue to rise, but the risk involved in taking that type of unvented capital will also continue to grow. Many early stage companies are looking for the right investment partnerships to help their company grow, not just capital, which crowdfunding does not necessarily provide. It can be a good infusion of seed capital to launch a product or service, but founders would be wise to not consider crowdfunding as a constant source of cash flow.

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