Equity Crowdfunding is now an option for retail investors. What does that mean?

Equity Crowdfunding has recently become legal for retail investors in Australia. This a change that has been shown overseas to boost funding options for early stage ventures.

An event was hosted last week by #fintechsydney & #Equitise. There were lots of good questions I’ve touched on here.

First, what do the words mean?

What’s equity crowdfunding?

You may have heard of crowdfunding before. You tip in a small amount of money along with a whole bunch of other people to get something off the crowd. It may be your friend’s great movie idea. It may be some new product. It may be recycling coffee grounds into a facial scrub to support farmers in Vietnam.

The common theme is what you get in return for your money. Once the project’s up, you get the product at a hefty discount. That may be premier movie tickets or 6 months supply of the facial scrub.

You’ve paid in advance. The founder uses that cash to get their venture off the ground. If they’re successful, they can say thankyou by giving you access to the fruits of the labour either for free or a hefty discount.

Equity crowdfunding is different in that you get a share of the company (that owns the new thing created). In that element, it’s the same as buying shares on the stock exchange. In many areas, there’s a lot of differences there I’ll cover below as that’s important to know what you’re buying.

What’s a retail investor?

Most developed countries have a concept of “retail” and “wholesale” investors in their securities rules. What are those? The rules that govern how companies operate in that country.

In Australia, the words used are “retail” and “sophisticated” investors. Sophisticated investors are those who earn more than $250,000 a year or have more than $2.5m in net asset value. If you own a house outright in Sydney, chance are you qualify.

“Sophisticated” basically means “rich”. I use the term “wholesale” investor. Why? I’ve met several “sophisticated” investors who don’t necessary make “sophisticated” decisions.

The idea is that sophisticated investors are rich enough to afford advisors . Hence they don’t need protection at a legislative level. Whether they choose to follow that advice is of course a very different matter.

A retail investor is someone who doesn’t qualify as “sophisticated”.

Retail investors were restricted from being able to buy shares in private companies. That’s companies not listed on the stock exchange, which is the case for most early stage ventures. The equity crowdfunding rule changes now allow this to happen, within a set of rules.

If you’re a retail investor, what can you now do?

If you’re over 18, you can invest up to $10,000. This is done through crowdfunding platforms that are starting to emerge.

Those platforms will guide you through a process to ensure you’re eligible. For example, those platforms need to comply with “Know Your Customer” (KYC) rules that are designed to stop money laundering and back door terrorist funding. Are they a pain? Yes. The fact the platform owners take those rules seriously is important to build trust that they’re credible in the first place. If they don’t have those checks, chances are they’re a scam.

What to watch out for as a retail investor?

If you’ve got a friend who’s convinced their idea will be the next Facebook, and you want to get in on the action early, this is a great way to do it.

Remember for every Facebook, there were several other failed attempts that you now never hear of. That may be down to the founder. Often it’s not, there’s lot of external factors (including a healthy dose of luck) that determine who the next Mark Zuckerberg is. Hence if you’re happy to put this in and never see the money ever again, your friendship has a chance of surviving if things don’t go to plan.

This is also a very high risk investment (so is BitCoin). Angel investors (who traditionally have come from the those known as “sophisticated” investors), are the group who do the best our of early stage investors. They have learned how to make investments the hard way, by making lots of them and many of them failing. Like many things in life they have learned their craft through experience and after time that can start to yield fruit. Not always, however as a group they do better than most.

It’s also a very long term investment. Again using the example of angel investors, the average payback starts from 7 years and goes up from there. Once an Angel investor buys shares, there’s very few opportunities to sell them before what’s known as the “exit” event, where the founders either sell the business or IPO it, which means to list it on a stock exchange where shares can be freely traded.

If you’re a retail investor looking to “play”, do some reading on angel investment. There’s a lot of blogs out there about what the “secrets to success” are and also the realities of finding that success.

For shares you buy on a stock exchange, there are very rigid rules on the information the Company needs to provide, and how they communicate that to you. It’s extensive and the costs of preparing it and communicating it to sharesholders are very high. That cost alone stops a lot of early stage ventures from listing on stock exchanges as a way of accessing funds.

In the equity crowdfunding rules, a lot of these rules have been relaxed to ensure early stage ventures can make the most of these rules. That leads me into my next point.

The importance of really good communication

For founders, this is great news, and something worth exploring.

Not surprisingly, those who are doing well overseas so far are those with large networks already, whether that be their user base, readership or customer base.

Having done capital raising for 7 years now for early stage ventures, there’s a universal truth. How well you communicate with your potential and new investors will determine if they’ll give you money next time you need it.

Similar to the cost of selling to new vs existing customers, it’s a lot easier to raise money from existing investors than new ones.

If you’re an early stage founder raising money, be assured you’ll need to raise money again in the future. I also focus on the next capital raise to help determine the right strategy for this round, to make sure you’re not shutting any doors (or are ok with those you are shutting).

In traditional fund raising from a small group of sophisticated investors (whether they be Angels or VC’s), you had a group of insiders and communicating with them on how the money is being spent and the results you’re getting (or not getting) is not easy but at least it’s with a small group.

The communication strategies and practices for Equity Crowdfunding will evolve. It’s clear that those who are successful will be those who do this well.

The main things to remember:

- If you’ve tapped your existing networks (users, readership, customers), these are your fans. They need to be engaged with. They need to be excited by what you’re doing. They need to know this is something they can tell all their friends.

- They’ve laid cash on the line. This is no small thing. The world is littered with friendships and relationships that have been destroyed when this happens. The same will be true for your loyal fans. They want to know you care.

- There’s not a “legal template” for any of this. Hence this is a good area to explore in how you can improve your engagement scores with your audience. Your motivations here will come through loud and clear in your communications. In the online world there is no longer anywhere to hide.

- Everyone’s spectacular at the good news stories. How you communicate when things aren’t going so well (which will happen) will be the difference between those who do well with this in the long term.

The potential of this change is substantial. There will be some spectacular failures on the way through. How those are communicated and managed will have a direct impact on the success of this change for the whole industry.