Venture Capital versus Equity Crowdfunding

Venture capital. It sounds so cool right? The phrase invokes images of Silicon Valley sharks and hotshot Stanford drop outs dueling over the soon-arriving billions from the next Apple or Google.

The reality is different. First, venture capitalists are wrong most of the time. Only around 15% of venture-backed firms become superstars. That doesn’t mean the rest fail, but it does mean VCs lose most of their bets.

This guy really isn’t that cool

Venture capital comes with strings, of course. VCs might get vetoes over certain big decisions regardless of board composition. In addition to control, they may provide poor advice or have different intentions than company founders. According to one Harvard Business School study more than half of all VC funds delivered no better than low single-digit returns on investment. Worse, only 20 percent of funds achieved 20 percent returns (or better), a figure that they might be expected to deliver. Incredibly, nearly one in five funds delivered below-zero returns.

But if the company is a winner the story still flops. Half of all founders are removed within 18 months of their first funding round. The odds jump to 90% after three years. While the Googles and Ubers could negotiate founder-share voting rights with disproportionate power, most can’t.

For decades companies needing capital to scale had little choice but to play the VC game. But like the rollerblade, those days are over. Now companies can raise capital from many people who each have a small stake and no say in management. Equity crowdfunding allows the masses to evaluate a company’s chances for success while dispensing with the VC trap of board seats, special vetoes, and bad advice. The current maximum for a Reg CF raise is $1.07M over a 12-month period (a cap likely to rise through Congressional action). More established companies can utilize Reg A+, which caps at $50M.

As with anything, equity crowdfunding comes with tradeoffs. The company doesn’t get a lump sum, the raise comes over time, and there is no guarantee the company will hit its goal. Companies must often hire marketers to help boost their raise and the cap table includes lots of small investors. But those small investors are also stakeholders invested in the company’s success and depending on the type of company, potential clients or customers. In return for the extra hassle, the company controls all future business decisions.

Of course, these two capital-raising methods needn’t be mutually exclusive. Venture capitalists sometimes want to see the marketplace prowess a successful equity crowdfund can bring before investing. They can also be investors in an equity crowdfund with side-negotiated perquisites.

Most importantly equity crowdfunding now gives the company options it didn’t have just a few years ago. It allows them to forego venture capital altogether or negotiate from a stronger position.

If your company is thinking about raising venture capital you may want to rethink your business strategy and try a Segway, rollerblades are so 1990s.

By Jossey PLLC

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