Equity crowdfunding is eroding the best returns VC funds used to enjoy

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VB | | May 13, 2018

There’s been a sea change in Series A investment rounds that has been gradually – but persistently – eating away at venture capital (VC) funds’ highest-ROI category investments, and the reason it’s happening may surprise you.

According to Cooley’s VC trends, the median Series A valuation has moved up from $16.5 million to $23.0 million in just the past two years. VCs aren’t just competing for fewer early-stage deals, they’re also paying a lot more for them. Around the time that orange became the new black, seed rounds became the new Series A, with valuations doubling between 2012 and 2017, according to Pitchbook. (What used to be called seed-stage is now termed “pre-seed.”)

How we got here

You might think this is just an organic consequence of too much money chasing too few deals, especially given that the last time we saw this much VC investment was in pre-bubble 1999. Ironically, one of the most powerful changes brought about by dot-com was the democratization of angel investing in startups, taking many early stage deals off the table before VCs could get a look at them.

Based on over 30 years of raising capital, plus my own participation in the ecosystem as an angel investor for the past last 20 years, my sense is that widespread angel investor empowerment began after the dot-com bubble. By 2000 a lot of “new money” investors were minted, and only a relative few had taken enough gains off the table before the bust to be able to invest in venture capital funds. Many took to the streets, joining angel investment clubs and online communities to start sprinkling their money around on green shoots.

See:  Jan 8, 2018: Intro Presentation on Raising Equity and Funding for your Startup

As fans of the TV show Startup Junkies will recall, in 2007, my company at the time, Earth Class Mail, was faced with the dilemma of whether or not to accept a venture investment from Ignition Partners (the largest VC fund in Seattle at the time). We raised a lot of eyebrows among Silicon Valley VCs for raising $12 million in angel money, including $8.9 million from 96 Keiretsu investment club members alone (what “crowdfunding” was before it moved online). Most VCs were dismissive of the investment prowess of angel groups at the time.

Take VC money, lose control

Our concern over taking VC instead of more angel money? By investing just $6 million out of a total of $18 million, one VC would redefine the Series A term sheet, effectively take control of the board, and ultimately determine the company’s destiny.

That concern turned out to be justified. After all, we had a good thing going with an army of “brand ambassador” angel investors who helped us find customers, strategic partners, and plenty of capital. Alas, our management team was drawn to the allure of a prestigious VC investment like a moth to a burning light.

We knew that taking institutional VC with aggressive Series A preferences meant ceding control to a single concentrated investor.

Just one year later, Ignition had its own internal scandal that caused an implosion within the partnership. The shrapnel impacted many of its portfolio companies, including us. As a result of this external event, our founders, 70 percent of our employees, 140 angel investors, and three board members were kicked to the curb. The company lost its engine room and bridge in one catastrophic event, sending it into survival mode for the next five years and an eventual packaged bankruptcy designed to get only the VC’s money out when the fund reached its 10-year term.

For my next startup, I went to the fledgling AngelList platform (before they introduced deal syndication) and put our seed round together from a handful of savvy angel investors pitched over a web conference, and a F500 corporate strategic investor.

I used AngelList again with my current startup, iMovR, to raise a quick $225,000 round through the Barbara Corcoran Venture Partners syndicate in 2015. Even angel groups were beginning to lose their popularity due to the many time-consuming stages of their processes.

An exciting alternative: Equity crowdfunding

It was the JOBS Act of 2012 – creating Title III and Title IV equity crowdfunding structures – that ultimately squeezed VCs out of many of the best early-stage deals. Why? Instead of just the four percent of the population that have the income to declare themselves accredited for participating in Reg D rounds, anyone in the general public could invest in a Reg CF or Reg A+ offering.

While equity crowdfunding rounds attract large numbers of small investors, these angels become avid brand ambassadors for companies and help them generate more visibility and sales. The SEC even managed to catch some of the lightning of Kickstarter’s popularity by enabling “investor perks” as part of the security offering, now a fairly common feature of crowdfunding deals.

More: 

Eighteen months ago, I started a spreadsheet to track dozens of crowdfunded deals to help us choose between Reg CF, Reg A+, and the new breed of “side-by-side” Reg CF/Reg D hybrid offering structures. At the beginning there were virtually no other companies at our stage of revenue ($10 million+). A study commissioned by the SEC indicated one-third of the crowdfunded companies were pre-revenue, and the majority had generated under $1 million in sales. Issuers were often first-time entrepreneurs.

Remarkably, in recent months there have been numerous Reg A+ and side-by-side rounds issued by companies with $5 million-$15 million in revenues-to-date and led by seasoned entrepreneurs who clearly had the connections and track records to raise traditional VC. In interviewing some of these CEOs I sensed many of them chose this path after having similar challenges with VCs in their prior ventures.

Many angel investors have startup experiences of their own and have seen first-hand how some VCs can push perfectly good companies to exit too fast or for valuations that advantage the VCs over all other stakeholders. They also recognize that investing directly into companies means they get to pocket the fund expenses and 20 percent profits interest that are deducted before winnings are shared with limited partners.

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The National Crowdfunding & Fintech Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with cryptocurrency, blockchain, crowdfunding, alternative finance, fintech, P2P, ICO, and online investing stakeholders globally. NCFA Canada provides education, research, industry stewardship, services, and networking opportunities to thousands of members and subscribers and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding and fintech industry.  Join Canada's Fintech & Funding Community today FREE!  Or become a contributing member and get perks. For more information, please visit:  www.ncfacanada.org

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