The rise of equity crowdfunding

Where did equity crowdfunding come from and will we see another surge in the wake of a new economic downturn?

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By Vanessa Malone

Equity crowdfunding is a capital raising method typically utilized by startups and small businesses, whereby a company uses the internet to sell securities (shares, debt, or other ownership rights) to a large number of customers and fans.

The rise of equity crowdfunding began during the recovery years that followed the 2008 financial crisis. In the wake of the economic downturn we’ve found ourselves in as a result of the COVID-19 pandemic, it is worth taking a look at the history of crowdfunding as it may shed light on what we can expect moving forward.

Capital is the the driving force that fuels a company through the many stages of growth. While larger businesses traditionally turn to capital markets or to an existing audience of investors to raise necessary funds, these options are generally less accessible for start-ups and other smaller companies.

This all came became blatantly apparent during the 2008 financial crisis. Stock markets were plummeting, banks were no longer lending to start-ups and small businesses, and an increase in regulations made it nearly impossible for small businesses to raise capital through existing securities markets.

The dire state of the financial industry led small businesses to seek funding through alternative means. As a response, entrepreneurs looked to the internet and to their fans for support. So began the digital evolution of early-stage capital raising.

The first wave of crowdfunding was referred to as rewards-based crowdfunding. This gained traction in 2009 when Kickstarter and IndieGoGo launched and streamlined the ability for people to invest in companies they loved in exchange for a type of perk or reward. A plethora of niche crowdfunding platforms popped up alongside them.

Shortly after, crowdfunding got a boost from the White House. In April of 2012, President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act. The JOBS Act aimed to increase access to capital by lessening regulation burdens on small businesses.

From there, we saw the emergence of the exempt securities market which featured capital raising frameworks with investor eligibility updates, less disclosure agreements, and less registration requirements. Now issuers had the opportunity to “generally solicit” or market their investment opportunity through social media and other online mediums.

Instead of investors getting a t-shirt or other type of reward for giving money to support small companies, investors could receive equity ownership in the company in exchange for their investment.

The most utilized equity crowdfunding offerings are conducted using Regulation CF and Regulation A+. Rule 506(c) of Regulation D also enables issuers to market their opportunity to a large audience of investors but only high-net worth or accredited investors may participate in these offerings. Rule 506(c) of Regulation D went into effect September 23, 2013; Reg A+ on June 19, 2015; and Reg CF on May 16, 2016.

Since their inception, exempt securities offerings have significantly outpaced registered offerings.

In 2019, registered securities offerings accounted for $1.2 trillion (30.8%) of new capital while exempt securities offerings accounted for $2.7 trillion (69.2%) of new capital (this includes Reg D, Reg A+, Reg CF).¹

It is clear that equity crowdfunding is changing the way companies fund-raise. A combination of high costs associated with going public and upgrades from the JOBS Act has helped make it possible for companies to stay private longer, with some tapping into their audiences for fundraising needs.

In the wake of this new economic downturn, we can expect entrepreneurs to continue to depend more on this burgeoning capital raising trend. New positive modifications to the equity crowdfunding rules and the obvious benefits to issuers support this claim.

In March, the SEC proposed amendments to the Reg A+, Reg D, & Reg CF exemptions. The amendments would increase the maximum amount an issuer can raise in a Reg CF offering from $1.07 million to $5 million, and from $50 million to $75 million in a Tier II Reg A+ offering. Additional changes are proposed to reduce friction and better investor eligibility requirements.

In addition to regulatory support, the added perks of raising funds through equity crowdfunding are also becoming more clear as the market matures.

Marketing an investment opportunity to fans using online platforms removes the need to travel or have in-person meetings, something that has been made more difficult during the pandemic.

Equity crowdfunding not only widens the net of potential investors a company can reach, it gives companies the opportunity to create strategic brand ambassadors with a vested interest in the growth of the company. Building and generating loyal customers who have a stake in your success can be a great way to secure support during the good times and the hard times.

Equity crowdfunding also opens the doors for investors of all levels. Right now those who can are working hard to support companies they love. Investing in a crowd-financed offering is one way to offer support and a vote of confidence for companies continuing to grow throughout this pandemic.

The change of financial climate following the 2008 financial crisis has introduced a cultural and digital shift to capital raising. Especially as the market infrastructure continues to mature, we believe that we will see the equity crowdfunding trend to continue upwards in light of this new economic downturn.

If your company is seeking to conduct a securities offering, Horizon offers a one-stop-shop from primary issuance, KYC/AML investor onboarding, custody, all the way through to secondary trading. Visit us at https://www.horizonfintex.com/ or email us at horizon@horizonfintex.com for a demo.

About Horizon:

Horizon offers a suite of integrated securities software applications for compliant issuance through secondary trading of electronic securities. Truly a compliance-first business, our solutions combine Wall Street and Silicon Valley to power the next generation of exchanges and securities offerings in the U.S. and globally. Visit us at https://www.horizonfintex.com.

Sources:

¹ SEC Capital Formation Report

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