Bridging Gap Between Crowdfunding Portals and Stock Exchanges

taking companies publicThe size of the gap between private and public companies has ebbed and flowed with similar changes in regulation, opportunity and innovation. Unfortunately, the size of the gap can be a detriment to many a small company seeking access to the public markets. While there are more reasons than one for taking a private company public, the greatest motivation is easier access to capital and greater liquidity. Providing access to capital is at the heart of some of today’s most innovative crowdfunding platforms. Whether through crowdfunded debt or equity, business and real estate opportunities are able to tap large groups of potential investors using the networking power of the web, combined with the sharing power of social platforms. It’s been overly-heralded as the capital raising savior of fledgling private business. While some of the capital raising features available through crowdfunding platforms represent a boon to companies and entrepreneurs seeking capital, gaps still remain. Specifically, lack of liquidity and minimal risk disclosure is likely to slow what has been touted as a fundraising cure-all. As a result, we expect some of the gaps in equity crowdfunding will only be bridged by taking companies public.

The Shortfalls of Crowdfunding

Make no mistake, crowdfunding represents a huge opportunity and one of the greatest shifts in business finance in a generation. The ability to source funding online from thousands (or more) potential investors is truly game-changing. The opportunity for this type of finance for privately-held business has been heretofore unavailable. But what about the financing after the financing? How are crowdfunded businesses expected to deal with hundreds of investors, some of whom may clamour for their money back a year or two in the future? What if more capital is required? If larger, institutional investors come on board, will the original shareholders get diluted? If a company shareholder wishes to sell his/her shares, where is there a secondary or efficient market for doing so?

And while most countries, states and territories have annual limits for unsophisticated investors as a protection mechanism, it doesn’t mean that such investors won’t make unwise bets on single deals or opportunities. The inherent risks in crowdfunding opportunities creates a situation reminiscent of stock markets before mutual funds–a time when risk couldn’t be completely mitigated. To the unsophisticated and unwary, this creates too much exposure to non-idiosyncratic risk in a single deal.

In addition, most due diligence in any crowdfunding opportunity, even at its best, is nothing near some of the stringent policies for selling securities on an open exchange. This type of investor protection mechanism isn’t–and likely won’t be–as stringent on many a crowdfunding platform.

Bridging the Gap

Not every company that raises capital through crowdfunding will be the poster child of the crowdfunding industry’s shortfalls, but it’s certain that many will run into at least some of the obstacles just discussed. Avoiding or preventing such issues will likely involve some mix of creativity and expert understanding.

Here’s a for instance that may prove helpful. ABC company receives several million in seed funding from a crowdfund campaign. The company develops its product and begins selling it to consumers with mediocre success. Two years go by. The several hundred unsophisticated investors–each of whom may have a few thousand in the deal–start to demand some return or liquidity on their initial investment. If they don’t get what they want, they may become miffed, which could ultimately prove detrimental to the company. Taking such companies public through some of the less known exchanges may be the best way to salvage such demands when they arise, and they will arise. The benefit is that many such deals will have an existing, large shareholder base, eliminating at least one of the biggest barriers to public stock acceptance.

Many of the other issues, including full disclosure and investment diversification can be had through such a mechanism and the cost is cheaper than most people think.

Ensuring crowdfunding is successful will require a mix of panache and brains. Surely the public markets are the best mechanism for bridging some of the gaps and issues inherent to businesses accepting money from crowdfunding. When looked at objectively, it could easily be argued that crowdfunding is nothing more than the lowest and least legitimate version of typical stock market offering, like a pink sheet or a grey sheet. The only difference is that at the end of the day, you can’t get your money back.

Nate Nead is the Managing Partner of Crowdfundraiser.com, a company that focuses on creating liquidity for privately-held crowdfunded businesses. His firm seeks to solve some of the most fundamental issues relative to crowdfunded business and most often works with companies after they’ve received a successful financing through a crowdfunding portal. You can connect with the team at @Crowdfundraise.

Posted in Capital Formation, crowdfunding, Entrepreneurs, Start-ups

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