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March 10, 2020

Will Equity Crowdfunding Replace Angel Investors?

Will Equity Crowdfunding Replace Angel Investors?

The JOBS Act legalized equity crowdfunding, disrupting the traditional investing environment, which limited venture investing to accredited investors. Thanks to the JOBS Act, even a non-accredited investor can participate in equity crowdfunding startup investing since the JOBS Act removed the requirement of having an annual income of $200k for the past two years (or $300k if combined with a spouse). This has opened the possibility for anyone to become an angel investor. 

Reg CF also relaxes other securities act filing and reporting requirements to reduce the costs and labor burden on companies utilizing Reg CF. Both Reg CF and Regulation A+ help startups crowdfund equity investments. On the other hand, their users, fans, clients, and small-time investors can invest and expect a return on their investment.

In 2018, the statistics show that more than 300,000 angel investors invested above $26 billion in startups in the U.S. In Europe, more than 310,000 angels invested more than €9 billion in startups in Europe. According to the WBAForum report, the total global market size of angel investment is more than $50 billion every year. As for the equity crowdfunding market, Startups.com reports that global equity crowdfunding raised $2.5 billion in 2018. The number of investors who participated in successful investment offerings increased from 77,558 to 147,448 (from 2017 to 2018). Despite equity crowdfunding being in its infancy stage, SEC reports that it is rapidly growing into a viable source of financing.

But the questions that arise are – how does equity crowdfunding affect angel investors and venture capitalists who have been the biggest early-stage business investors for so long? Is equity crowdfunding replacing angel investments? Can equity crowdfunding and angel and VC investors coexist? Should a startup founder go to equity crowdfunding investors or angel investors?

Funding the Underfunded Enterprises

If we were to compare angels to venture capital funds, angels are more patient. They have less aggressive goals and fund more businesses than traditional VCs because the average deal size is much smaller. Often, they are established business owners themselves. However, both are looking for an internal rate of returns (IRR) of 20%-40% over 5-7 years. A sophisticated investor is typically picky when it comes to which businesses they choose to fund. About 50% of startup companies don’t make it past the fifth year. Therefore, an experienced, accredited angel investor will look for startups with the best chances of succeeding.

 

The statistics also show us that most accredited angel investors in the U.S. are white males, and most of the founders of startups are also white men. When it comes to Regulation Crowdfunding, female founders make up 22% of investment offerings. Even though they own 38% of businesses in the U.S., female business owners get just 2% of all VC funding (according to HBR). This points out to an evident gender gap in VC funding in the U.S. Even in Silicon Valley, we can see that a lot of groups are underfunded or underrepresented in startup funding. Geography, age, gender, and ethnicity play a disproportionate role. Thanks to equity crowdfunding, getting investors’ attention became easier for small businesses.

Despite being a young sector within the young crowdfunding industry, equity crowdfunding is helping diversify the startup and early-stage business ecosystem. It is already bridging the gender-bias gap by changing the system of access to capital. As a way of supporting each other, more women are investing in female-led companies as well.

Equity Crowdfunding vs. Angel Investors: Democratization of access to capital

Traditionally, early-stage ventures raise capital through angel investors and VCs (a VC firm typically consists of VCs or general partners managing independent VC funds raised from limited partners). However, the number of startups that have raised capital is very low. A startup that received angel capital is most likely to be located in metros such as Los Angeles, New York, and San Francisco because these centers attract the best entrepreneurial talent. As for the rest of the U.S., it is left out and goes underfunded. Equity crowdfunding changes the game becoming a way to bypass this issue and provide another way for startups to get funded.

Crowdfunding campaigns can also reduce the time to raise money, lower the cost, achieve investment compliances, and help fund a broader range of companies. In such a scenario, angel investors will need to adjust their investment model.

Also, angel investors make high-risk investments for lesser returns. Much of angel funding happens on a local level and through word-of-mouth among a network of people. Therefore, startups often have to clamor for investments. With equity crowdfunding, early-stage companies don’t need angels since they can raise even more money on an equity crowdfunding platform. There, investors can shuffle through many startups with interesting, lucrative, and innovative ideas (the website ensures that the investor receives equity for their participation in the capital of the startup that needs it). An accredited angel investor is always on the lookout to invest in an exciting, potentially lucrative portfolio company, but don’t always hear about them in time. 

What are the Key Differences between Equity Crowdfunding and Angel Investing?

Although angel investing and equity crowdfunding coexist both online and offline, their conditions differ. 

  • Difference in the negotiation period. The negotiation with angel investors can last months while the startup demonstrates its viability. While in equity crowdfunding, the period favors dynamic operations. Also, because small amounts of money are involved, equity crowdfunding investors don’t have an economic incentive to undertake due diligence.
  • Difference in social proof. Angel investors typically get proof from other investors or a network of people from the company’s industry. It shows that a startup can close good deals and seal partnership deals with other high prolific investors. With equity crowdfunding, the social proof the size of the crowd that already shows interest. Investors want to get a real sense of what the public has to say about a company.
  • Difference in the project selection process and investment mechanism. Equity crowdfunding has become the preferred option for early-stage startups because they can make one pitch to numerous potential investors instead of several pitches to many investors. 
  • Difference in the limit of funds being invested. On equity crowdfunding sites, you could invest anything between $50 and $100,000 (depending on your annual income and net worth). That allows individual investors to enter the venture capital investing arena, opening up a diversified pool of investment opportunities.

Equity crowdfunding can become the bridge between individuals looking to invest in startups and companies deserving of funding. Early-stage startups that don’t find any favor among angel investors can enjoy a new level of acceptance in the equity crowdfunding ecosystems. To avoid becoming another startup failure, it’s all about raising smart startup investments. Furthermore, the wisdom of the crowd can lead to improving the quality of projects that are in the market as well as lead to more private companies that search for VC financing. Startup incubators or accelerators are also there to help startups attain success. By embarking on a startup accelerator program, startups can get resources, advice, mentorship, and other human resources support they need to succeed and participate in Demo Days that are attended by media and investors. 

Ultimately, a successful crowdfund will always depend on the startup’s offering. Active communications based on social media, email newsletters, content marketing, and other online marketing tactics also play crucial roles. 

We see many IC (intellectual capital) and IP (intellectual property) driven companies successfully get funding. However, we also expect to see other investment products, such as mining, oil exploration, and real estate assets, to gain more traction. 

Many successful companies owe their success to the support of angel funding, meaning that equity crowdfunding won’t replace angels or VCs anytime soon. But crowdfunding has entered the scene as a new road that startups can embark on, which removes venture capitalists and angel investors as the main gate between startups and funding.

KingsCrowd can help you make well-informed investment decisions as well as educate you on the current startup environment. Subscribe today for more in-depth information! 


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