Equity Crowdfunding: Poised to Disrupt the Angel Landscape?

By Megan Maltby

There is no question that access to capital is often limited for startup entrepreneurs. Equity crowdfunding- online fundraising in exchange for ownership in a company- promises to open another avenue for startup capital, and a way for the “crowd” to hopefully receive a return on investment.

Canadian securities regulators in five provinces have introduced two exemptions for companies that plan to raise money via equity crowdfunding. Entrevestor provides a great overview of them here. Startup companies themselves are limited to fairly small raises (up to $1.5M under the “Crowdfunding Exemption”). Investors are also limited to an investment ceiling (per-deal, and in some cases, an annual cap).

Equity crowdfunding may seem like the next big disruption in a somewhat old-school practice. But what does it mean for angel investors? First let’s look at the benefits:                                    

  • Greater access to deal flow: Angels do not have to wait for scheduled meetings to view deals, and they are also not limited to a geographic area. Some angels may want to deliberately invest outside their home region- perhaps to gain access to tech or medical hubs.
  • Reduced due diligence requirements: The equity crowdfunding practice is intentionally scaled down, making it the perfect route for angels with limited time for opportunity review. Round sizes and individual investments are small, leading to reduced time and effort spent on due diligence. Many angels would be willing to part with $1000 after a quick overview of the company’s online profile (a $50K investment would be a different story!).
  • Diversified portfolio: For investors looking to spread their wealth and mitigate risk, crowdfunding provides a fast route to portfolio investment. For example, an angel looking to spend $50K/year on investment activities would typically invest in 1-5 companies. Using equity crowdfunding, that same $50K/year could be invested into 10+ companies.

While the benefits are clear, the equity crowdfunding landscape still needs a lot of work. Some issues that should give angels pause:

  • Limited investment/limited upside: Under the “Crowdfunding Exemption” individual investors are limited to $2500 per deal, and accredited investors are granted a somewhat higher limit of $25K per investment. Obviously, with limited investment parameters comes a limited return potential.
  • Complicated cap table: With the cap on individual investments, companies raising money via crowdfunding must be prepared to take on dozens or even hundreds of new investors. Angels typically like to invest with like-minded individuals. The idea of participating in a deal alongside hundreds of other investors without much skin in the game, is not appealing.
  • No negotiation of valuation and terms: It is too early to tell how crowdfunding portals will be implemented in Canada. However, in the UK, platforms fall into one of two categories: entrepreneur-led, where the founder sets the terms of the deal, and investor-led, where a lead investor negotiates the terms and the crowd can then follow[1]. Angels should be prepared for crowdfunding deals presented on a “take it or leave it” basis, with no opportunity for input.
  • Underperformance: With hundreds of shareholders, company managers will be spending significant time on investor relations, and could get bogged down in administration and reporting. Investors should be aware that this means less time and energy spent on what really matters- growing the business.  The flip side of this is that hundreds of investors could be ignored since none of the crowd involved in the funding has any leverage to ensure adequate reporting by the company. 
  • Limited mentorship:  Studies have shown that the probabilities of success for angel investors increase with the amount of involvement they have with the company post investment.  With equity crowdfunding, the ability to interact with the founders will be extremely limited due to the large number of individual shareholders and the impersonal fundraising process. Many angels invest not only to garner a financial return, but to also give back to their communities and mentor the next generation of business leaders.

Any effort to improve access to capital and lower barriers to investment is, of course, positive. Time will tell how the equity crowdfunding market will play out in Canada. While accredited investors may choose to use crowdfunding as a supplement to their regular angel activities, I personally do not foresee equity crowdfunding replacing the traditional angel fundraising model.

 

 



[1] http://www.forbes.com/sites/goncalodevasconcelos/2014/08/08/top-5-things-you-should-know-about-equity-crowdfunding-platforms/#18a13b92acf9