August 24, 2016

Equity Crowdfunding vs. Venture Funding

Nathan Rose
Founder of Assemble Advisory

Guest post by Nathan Rose, Assemble Advisory

Venture capital (and angel investors and private equity) were just about the only option for early stage companies to go to when they needed cash, before equity crowdfunding came along.

There is no doubt that the right venture capital firm can be a valuable partner. For a lot of startups, though, the “venture capital way” of doing things clashes with their company culture.

Alicja Chlebna runs Naturalbox, a Swedish company which delivers ethical, organic snacks, health and beauty products through a subscription service. “No banker would share the passion I have for my business. And most venture capitalists are pretty arrogant, greedy and difficult to work with, from what I know”. Strong words, but it isn’t difficult to find startups who feel this way.

There are many advantages to using a public equity crowdfunding raise, versus venture capital.

1.     Easier to access

Equity crowdfunding enables you to raise money, even if you don’t have the ‘connections’, because it puts the decision into the hands of many more people.

Mark Hughes of Tutora had this to say about their efforts to reach out to venture capital. “They are incredibly hard to access. The main pushback was we were too small – even though we had real customers and real revenue, they were just looking for something bigger; millions of pounds.”

“The other pushback we had was ‘we don’t know who you are’. Venture capital in London is very much a closed, old boys shop. They only want people coming to them who have come with a recommendation. It makes it really hard if you come from somewhere like the north of England where there’s just not a lot of venture capital activity going on”.

2.     Better outcome on valuation

The industry is divided on whether equity crowdfunding is achieving higher valuations than those negotiated by venture capital. But the balance of evidence suggests that higher valuations are indeed being achieved.

Venture capitalists are highly experienced in making investments. It’s what they do. When it comes time to talk numbers, they have a massive skill advantage over company founders who may be complete novices, or have been through to it a handful of times at most. When the valuation is being negotiated, they feel like they’re playing against a chess grandmaster, when they barely know the way the pieces move.

Equity crowdfunding sees the power dynamic far more in the company’s favour.

You may have heard finance industry insiders bemoaning the valuations being achieved in equity crowdfunding as “unrealistic”. It is hard to know whether to take these complaints seriously, or dismiss them as vested interests protecting their patch– the same way the traditional taxi drivers protest the advent of Uber. “How awful to think the venture capital position as the exclusive source of capital is being disrupted. [How] ironic that technology will eat its own creator”, quipped Howard Marks of StartEngine Crowdfunding.

3.     Better outcome on investment terms

One of the most important ways that venture capital firms make money is through the terms they insert into the deal. These terms are designed to be favourable to their position, often at the expense of the company founders.

“The terms from venture capital are always restrictive” says Laurence Cook of Pavegen. “They want board seats, control, liquidation preferences, restrictive terms on the founders – all things which don’t favour the company raising money.”

“The way venture capital make money is by negotiating hard. That’s their job, and they are very, very good at it. By raising money through the crowd, we were able to raise the money on our own terms.”

These terms protect the downside of the venture capital firm while still offering them many multiples of upside. It seems like they want to have it both ways – and, indeed, this is exactly what they want. Again, founders can try to negotiate, but their position is weak – they need the money, and they are afraid of the venture capital firm walking away.

By contrast, one of the real advantages of equity crowdfunding platforms is that they offer standardised documents which efficiently manage the real need for pre-emption rights and avoiding dilution, but do so in a way that is fair for both founders and investors.

4.     Publicity

One of the main reasons to conduct an equity crowdfunding offer is to build awareness of a company among new consumers. What is often overlooked is how effective it can also be for getting introductions to new suppliers, board members and other partnerships. When you put your company out there in such a public forum, people can notice and be attracted to your company in many ways. The ability to put your name out there to the world through a public equity crowdfunding campaign can be a game-changer through the exposure it gives.

Conversely, a deal with venture capital is done behind closed doors.

Remember, though that publicity can be a double-edged sword. It is great if your offer succeeds, because everyone will see that. But similarly, equity crowdfunding failures will be there in the public arena for all to see, while a failed deal with venture capital will never see the light of day beyond the boardroom.

5.     Broad shareholder base

Particularly for businesses that sell to consumers, an enlarged shareholder base can provide new passionate shareholder advocates.

Venture capitalists would also be advocates, through the networks and introductions they can provide, but for sheer number of advocates, equity crowdfunding wins hands down. Imagine having dozens, or hundreds of new people who are incentivised to look out for your interests, because your financial interests are now the same as theirs!

Another point needs to be addressed here, which is the fear that equity crowdfunding will make a company less attractive to venture capital in the future, due to a large number of shareholders making the share register “difficult to deal with”.

“Really, it depends on the firm” says Bret Conkin of Crowdfundsuite, “There’s certainly a group of crowdfunding non-believers in the venture capital community, but there is an increasing percentage who are buying into it. In some cases they are even combing through the crowdfunding platforms, as a way of finding new companies to invest in.”

Ultimately, business performance will be what matters. There will always be some people who don’t like dealing with new ways of doing things, but something like the share register is a very minor thing that can be worked out, if needed. If your business is going well enough, venture capital firms will look past a messy register, or find a way to restructure things.

Skai Dalziel of Guusto put it well: “The bigger risk is not having a successful company. The goal is to get to an operating business that generates profits. If crowdfunding is a way to get there, great.”

In the future, you would much rather have a business, even if venture capital show resistance to it because it has been funded through crowdfunding. It’s better than having no business at all!

6.     Doesn’t preclude “smart money”

When founders think equity crowdfunding, they can be envisaging having investors who don’t bring anything to the business apart from their money. When weighing this against bringing on board a single financial investor that promises to lend their time and experience to the business, founders become sold on this idea of having this “smart money” on their side.

But when a company runs an equity crowdfunding campaign, large investors aren’t excluded! Far from it, in fact. The platforms will encourage you to bring them to the raise – perhaps to lead the offer, anchor the demand and validate it in the eyes of the smaller shareholders.

A crowdfunding raise of $1 million may consist of one at $300,000, and the remainder in smaller amounts. That investor who contributed $300,000 may very well be the sort of person you might add to your board of directors and lend the same kind of expertise that the venture capital firm was going to.

In this way, it’s possible to use equity crowdfunding to bring more demand to the raise. Crowdfunding can be “as well as” venture capital, not “instead of” them.

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Nathan Rose is  the Director of Assemble Advisory, a finance agency for companies wishing to pursue equity  crowdfunding. Assemble  Advisory assists with picking the right platform, putting together offer  content and financial models, and campaign management - allowing companies to  raise money sooner.