Today’s question is a simple one:
Equity crowdfunding: good idea/bad idea?
The answer turned out to be more complicated, so we turned to Michael Hughes, Senior Director of Equity Crowdfunding at Indiegogo, to learn more about equity crowdfunding in general.
HWY1: What is equity crowdfunding?
MH: There are a lot of different types. The kind we’re mainly focused on at Indiegogo right now became legal in May of 2016 as a result of Title III of the JOBS Act, which allows anyone in the world 18 or older to invest in a startup or private company. Prior to last May, investing in private companies was limited to accredited investors (i.e. very wealthy people) only. That’s all changed: equity crowdfunding is a way to raise money from the crowd and take actual investment from your company’s fans and user community.
Is equity crowdfunding a good or a bad idea?
It could be a great fit for a lot of different companies at different times. We’ve been quite successful with a variety of verticals thus far — not just hardware and software tech companies, but movies, video games, restaurants, and distilleries. It’s an impossible question to answer unless we’re talking about a specific vertical and a specific company — it really depends on what stage they’re in and what their fundraising needs are. For hardware companies in particular, it’s a great way to truly engage a passionate community. They’re not just pre-ordering or buying the product; they’re investing in the company, and can participate in any potential upside.
Are there common factors that link the hardware companies you’ve seen do it successfully?
Over the last few years, Indiegogo has become very focused on hardware for our perks/rewards crowdfunding platform, so we have a lot of experience there. First and foremost, for equity crowdfunding, investors in general are looking for some sort of traction; ideally, a hardware company should already be shipping, as this de-risks the investment. Pre-orders are great market validation, but hard proof that the product is being made and shipped to people is even better to make a hardware company an attractive investment.
At what stage are companies mostly using equity crowdfunding?
It’s mostly early stage: seed or series A rounds. The way I like to think about equity crowdfunding is that it’s a great way to augment a fundraise. In fact, as far as hardware goes, the best company to me has early traction, a great team, a great product, and they’re already fundraising with part of the round committed from angels or more traditional institutional investors; such a company would be turning to equity crowdfunding to open a piece of the round to their community of users and fans. That does three things:
- It says to their community “You guys are the reason we exist, and now you can invest alongside other more traditional investors in our early round.”
- It’s a great marketing tool. The company’s opening up a piece of the round to their biggest champions, and can leverage Indiegogo’s worldwide audience of tech-savvy early adopters.
- It creates a pool of potentially hundreds of cheerleaders going forward who are literally invested in the company’s success.
Are there challenges involved after an equity crowdfunded raise? How do you manage having hundreds of investors?
It depends on the structure of the deal. The term “equity crowdfunding” is actually a bit of a misnomer; it should really be called “crowd investing” in my opinion. I mention this because you can use a variety of deal structures: a convertible note, revenue share, debt, equity, etc. Revenue share deals are popular with a lot of restaurants, distilleries, and other small businesses: they’re not giving up any equity, but simply paying people back a return on their investment over time from future revenues. If a company does do an equity raise, it’s true that there could be hundreds of potential investors, but there are ways to deal with that as far as cap table issues go. One structure that’s popular right now is called a Crowd Safe, which acts like a convertible note but allows the company to set the equity conversion to an exit, keeping the cap table clean for future fundraising. Title III equity crowdfunding requires companies to report quarterly to their investors, and our platform helps facilitate that going forward; the reporting isn’t very burdensome.
What are the main challenges to equity crowdfunding or crowd investing?
I think right now it’s just education, both with companies/entrepreneurs looking to do this type of fundraising and also on the investor side. Title III equity crowdfunding is brand new — a little over a year old — and most people still don’t know it’s even an option. On top of that, there’s a lot of misinformation and confusion out there: how it works, who can do what, etc. We’re committed to doing more education; if people have questions, we want to make sure they understand the pros/cons and all the risks involved. Once the startup community is better educated on this type of fundraising and investing, I think it’ll be adopted more. Right now there’s definitely a big education gap.
What are the red flags you’d look for in a company that’d make you advise them against attempting crowd investment?
We look holistically at every company, but traction is going to trump anything; we’re looking for at least some early traction, whether it takes the form of revenue growth, user growth, partnerships, etc. If you’re pre-product or pre-revenue, you’re probably not quite ready for our platform right now, but that doesn’t mean you won’t be a great fit in the future when you’re a little further along. A strong perks crowdfunding campaign is a great proof point for a hardware company; having that early traction is only going to help a company be more successful in their fundraising, especially with more experienced, accredited investors.
We also look closely at the team; we want to know it’s not just a side project for them. At the end of the day, if we’re putting an investment opportunity in front of our investor community, we want to make sure there’s a full-time team committed to that company’s success. A part-time team, especially if it’s the core people, could be a red flag.
I can’t highlight this enough: the ideal candidate isn’t necessarily a company that can’t raise money. Crowd investing is a great way to augment a raise, both as a fundraising vehicle and a marketing and promotional one.
