Private company crowdfunding – a quick guide for issuers and investors

Crowdfunding is a method used by private companies (those not listed on a stock market such as the NASDAQ, FTSE, or NIKKEI) to raise capital from the public.

The ‘public’ includes accredited investors using a regulated online investment platform or a dedicated investment link on the chosen company’s website, both facilitated by a regulated broker dealer infrastructure and technology.

This form of crowdfunding targets a large number of investors, offering the company’s securities in exchange for a proportionate stake in the business venture.  

There are 27 million private companies in the US alone, with thousands of shareholders, the private securities market being valued at $7 trillion last year and forecast to reach $30 trillion (source: Forbes 2021) by the end of the decade.

So, with fewer companies ‘going public’, the private securities market will potentially become the largest financial market of all.

Importantly, this fast-growing sector also has powerful compliance and protection measures in place.

And crowdfunding platforms, broker-dealers, financial professionals, transfer agents and regulators all have important roles to play to ensure information provided by companies seeking capital funding is genuine and not promissory.

Pros and cons for issuers (private companies)

Since the JOBS (Jumpstart Our Business Startups) Act came into force in the USA in 2014, crowdfunding has regularly proven it can deliver major private company investment successes.

Last year alone, showed a 1,021% increase in take-up and, while the global crowdfunding market was valued at $8.61 billion a year ago, it has soared to a staggering $113.52 over the past 12 months (all stats: Pitchbook) highlighting a massive increase in the popularity of crowdfunding for private companies.

Regulators have also increased the amount of capital private companies can potentially raise through crowdfunding per year to $75 million via Regulation A+.

This has drawn further attention from more established companies, who no longer have to go cap in hand to VCs, and risk giving away too much control.

Other key points:

No concentration of power – having a large crowd of investors with shares in the company, means that power is not concentrated around a small group of shareholders with a potentially hostile agenda

Building a brand through greater access to capital – crowdfunding offers private companies the chance to build their brand and be heard by larger groups of private as well as accredited investors. Those investors can become great advocates for the brand, its products, strategy and even its ethical stance.

Attracting Talent and Business Opportunities – many startups or high growth private companies struggled to compete for and retain the best talent as they expanded, but crowdfunding has helped address this challenge.

New recruits may now potentially liquidate such assets much earlier than they were able to before the JOBS Act, due to the advent of secondary trading of certain private securities via a regulated secondary alternative trading system (ATS).

Through marketing their investment offerings, private companies can raise their profiles massively to attract future talent and customers. This trend is helping to democratize innovation and investment.

The biggest beneficiaries are often small to medium-sized private companies that have successfully built their business and reputation from crowdfunding. This is a real stimulus for local and national economies in terms of business growth and job creation.

Pros and cons for investors

Democratization of company investment – before the advent of crowdfunding a company’s holdings would usually be concentrated in the hands of a small minority of wealthy people, families and corporate investors.

The JOBS Act changed all that and enabled private company securities to be held across all parts of society, and investmnets to made on a much more modest scale individually or collectively.

Keyboard power – the crowdfunding boom has encouraged a wealth of online platforms and tools available to investors for sophisticated evaluation of private companies before they commit.

They can study company portfolios to check out those with the best potential for growth or success.

Or if possible financial gain is not the primary motive, they can identify companies working on something the investor truly believes in or identifies with, while avoiding those they dislike for ethical or other reasons.

You may lose all your investment – while there is the chance of a successful investment return in crowdfunding, there are also high risks.

Even the most promising ventures can fail without an adequate business plan and support structure.

So, while investing in private companies through crowdfunding can potentially yield above average returns, it is considered best practice to spread risk by investing across many private securities rather than just one or two.

Illiquidity and realizing value – exit options on crowdfunding platforms may be limited or may not exist, so an investor can still wait years to realize on their investment in a private company.

An investor may be required to hold onto their shares until the company:

  1. is sold
  2. issues an IPO (initial public offering) on a public stock exchange
  3. places its security on a regulated secondary trading platform known as an ATS (Alternative Trading System).

 

The growth of secondary market trading of private securities could potentially impact levels of liquidity (ability to access value) in private securities.

IMPORTANT NOTICE

Investors should recognise and accept the risks associated with investing.

Certain investments may require you to keep your holding for periods of many years with limited or no ability to resell unless there is a strongly regulated secondary market.

You may also have limited access to periodic reporting, see your holdings decrease and increase in value, or even lose your entire investment.

Investors should decide for themselves whether to make any investment, basing this on their own independent evaluation after consulting with financial, tax and investment advisors.

The Knowledge Hub does not constitute financial advice whatsoever, but rather provides basic general industry information.

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